Post-Keynesian Macroeconomics: Essays in Honour of Ingrid Rimda (Routledge Frontiers of Political Economy)

Post Keynesian Macroeconomics

Post Keynesian economics has focused primarily on the problems of unemployment from a macroeconomic perspective. The works of Ingrid Rima have provided a notable exception to this tradition and this volume examines some of her main ideas and contributions to Post Keynesian thought. The first part of this book analyses the links between Post Keynesian economics and earlier economic thinkers such as Quesnay, Marx, and Marshall. Further contributions in the second part of this volume discuss issues such as uncertainty, speculation, aggregate demand and aggregate supply, and government policymaking based on Post Keynesian macroeconomics and Post Keynesian models. The third section contains essays which expand on issues such as institutions, technological and sectoral changes, innovation and globalization. The contributions selected for Post Keynesian Macroeconomics demonstrate the breadth of Post Keynesian thought and its incisive analysis of real world problems. It also demonstrates how Ingrid Rima has moved Post Keynesian economics forward. Mathew Forstater is Associate Professor of Economics and Director of the Center for Full Employment and Price Stability at the University of Missouri at Kansas City. Gary Mongiovi is Professor of Economics at St John’s University and co-editor (with Steven Pressman) of the journal Review of Political Economy. His forthcoming edited book Sraffa and Modern Economics will also be available from Routledge. Steven Pressman is Professor of Economics and Finance at Monmouth University. He is the author of Fifty Major Economists (Routledge, 1999, 2006).

Routledge frontiers of political economy

1 Equilibrium versus Understanding Towards the rehumanization of economics within social theory Mark Addleson 2 Evolution, Order and Complexity Edited by Elias L. Khalil and Kenneth E. Boulding 3 Interactions in Political Economy Malvern after ten years Edited by Steven Pressman 4 The End of Economics Michael Perelman 5 Probability in Economics Omar F. Hamouda and Robin Rowley 6 Capital Controversy, Post Keynesian Economics and the History of Economics Essays in honour of Geoff Harcourt, volume one Edited by Philip Arestis, Gabriel Palma and Malcolm Sawyer

7 Markets, Unemployment and Economic Policy Essays in honour of Geoff Harcourt, volume two Edited by Philip Arestis, Gabriel Palma and Malcolm Sawyer 8 Social Economy The logic of capitalist development Clark Everling 9 New Keynesian Economics/Post Keynesian Alternatives Edited by Roy J. Rotheim 10 The Representative Agent in Macroeconomics James E. Hartley 11 Borderlands of Economics Essays in honour of Daniel R. Fusfeld Edited by Nahid Aslanbeigui and Young Back Choi 12 Value, Distribution and Capital Essays in honour of Pierangelo Garegnani Edited by Gary Mongiovi and Fabio Petri

13 The Economics of Science Methodology and epistemology as if economics really mattered James R. Wible

20 The Active Consumer Novelty and surprise in consumer choice Edited by Marina Bianchi

14 Competitiveness, Localised Learning and Regional Development Specialisation and prosperity in small open economies Peter Maskell, Heikki Eskelinen, Ingjaldur Hannibalsson, Anders Malmberg and Eirik Vatne

21 Subjectivism and Economic Analysis Essays in memory of Ludwig Lachmann Edited by Roger Koppl and Gary Mongiovi

15 Labour Market Theory A constructive reassessment Ben J. Fine 16 Women and European Employment Jill Rubery, Mark Smith, Colette Fagan and Damian Grimshaw 17 Explorations in Economic Methodology From Lakatos to empirical philosophy of science Roger Backhouse 18 Subjectivity in Political Economy Essays on wanting and choosing David P. Levine 19 The Political Economy of Middle East Peace The impact of competing trade agendas Edited by J.W. Wright, Jnr

22 Themes in Post-Keynesian Economics Essays in honour of Geoff Harcourt, volume three Edited by Claudio Sardoni and Peter Kriesler 23 The Dynamics of Technological Knowledge Cristiano Antonelli 24 The Political Economy of Diet, Health and Food Policy Ben J. Fine 25 The End of Finance Capital market inflation, financial derivatives and pension fund capitalism Jan Toporowski 26 Political Economy and the New Capitalism Edited by Jan Toporowski 27 Growth Theory A philosophical perspective Patricia Northover 28 The Political Economy of the Small Firm Edited by Charlie Dannreuther

29 Hahn and Economic Methodology Edited by Thomas Boylan and Paschal F. O’Gorman 30 Gender, Growth and Trade The miracle economies of the postwar years David Kucera 31 Normative Political Economy Subjective freedom, the market and the state David Levine 32 Economist with a Public Purpose Essays in honour of John Kenneth Galbraith Edited by Michael Keaney 33 Involuntary Unemployment The elusive quest for a theory Michel De Vroey 34 The Fundamental Institutions of Capitalism Ernesto Screpanti 35 Transcending Transaction The search for self-generating markets Alan Shipman 36 Power in Business and the State An historical analysis of its concentration Frank Bealey 37 Editing Economics Essays in honour of Mark Perlman Hank Lim, Ungsuh K. Park and Geoff Harcourt

38 Money, Macroeconomics and Keynes Essays in honour of Victoria Chick, volume one Philip Arestis, Meghnad Desai and Sheila Dow 39 Methodology, Microeconomics and Keynes Essays in honour of Victoria Chick, volume two Philip Arestis, Meghnad Desai and Sheila Dow 40 Market Drive and Governance Reexamining the rules for economic and commercial contest Ralf Boscheck 41 The Value of Marx Political economy for contemporary capitalism Alfredo Saad-Filho 42 Issues in Positive Political Economy S. Mansoob Murshed 43 The Enigma of Globalisation A journey to a new stage of capitalism Robert Went 44 The Market Equilibrium, stability, mythology S.N. Afriat 45 The Political Economy of Rule Evasion and Policy Reform Jim Leitzel 46 Unpaid Work and the Economy Edited by Antonella Picchio

47 Distributional Justice Theory and measurement Hilde Bojer 48 Cognitive Developments in Economics Edited by Salvatore Rizzello 49 Social Foundations of Markets, Money and Credit Costas Lapavitsas 50 Rethinking Capitalist Development Essays on the economics of Josef Steindl Edited by Tracy Mott and Nina Shapiro 51 An Evolutionary Approach to Social Welfare Christian Sartorius 52 Kalecki’s Economics Today Edited by Zdzislaw L. Sadowski and Adam Szeworski 53 Fiscal Policy from Reagan to Blair The left veers right Ravi K. Roy and Arthur T. Denzau 54 The Cognitive Mechanics of Economic Development and Institutional Change Bertin Martens 55 Individualism and the Social Order The social element in liberal thought Charles R. McCann Jnr.

56 Affirmative Action in the United States and India A comparative perspective Thomas E. Weisskopf 57 Global Political Economy and the Wealth of Nations Performance, institutions, problems and policies Edited by Phillip Anthony O’Hara 58 Structural Economics Thijs ten Raa 59 Macroeconomic Theory and Economic Policy Essays in honour of Jean-Paul Fitoussi Edited by K. Vela Velupillai 60 The Struggle Over Work The “end of work” and employment alternatives in post-industrial societies Shaun Wilson 61 The Political Economy of Global Sporting Organisations John Forster and Nigel Pope 62 The Flawed Foundations of General Equilibrium Theory Critical essays on economic theory Frank Ackerman and Alejandro Nadal 63 Uncertainty in Economic Theory Essays in honor of David Schmeidler’s 65th birthday Edited by Itzhak Gilboa

64 The New Institutional Economics of Corruption Edited by Johann Graf Lambsdorff, Markus Taube and Matthias Schramm

74 Growth and Development in the Global Political Economy Social structures of accumulation and modes of regulation Phillip Anthony O’Hara

65 The Price Index and its Extension A chapter in economic measurement S.N. Afriat

75 The New Economy and Macroeconomic Stability A neo-modern perspective drawing on the complexity approach and Keynesian economics Teodoro Dario Togati

66 Reduction, Rationality and Game Theory in Marxian Economics Bruce Philp 67 Culture and Politics in Economic Development Volker Bornschier

76 The Future of Social Security Policy Women, work and a citizen’s basic income Ailsa McKay

68 Modern Applications of Austrian Thought Edited by Jürgen G. Backhaus

77 Clinton and Blair The political economy of the third way Flavio Romano

69 Ordinary Choices Individuals, incommensurability, and democracy Robert Urquhart

78 Marxian Reproduction Schema Money and aggregate demand in a capitalist economy A.B. Trigg

70 Labour Theory of Value Peter C. Dooley

79 The Core Theory in Economics Problems and solutions Lester G. Telser

71 Capitalism Victor D. Lippit 72 Macroeconomic Foundations of Macroeconomics Alvaro Cencini 73 Marx for the 21st Century Edited by Hiroshi Uchida

80 Economics, Ethics and the Market Introduction and applications Johan J. Graafland

81 Social Costs and Public Action in Modern Capitalism Essays inspired by Karl William Kapp’s theory of social costs Edited by Wolfram Elsner, Pietro Frigato and Paolo Ramazzotti 82 Globalization and the Myths of Free Trade History, theory and empirical evidence Edited by Anwar Shaikh 83 Equilibrium in Economics Scope and limits Edited by Valeria Mosini

84 Globalization State of the art and perspectives Edited by Stefan A. Schirm 85 Neoliberalism National and regional experiments with global ideas Edited by Ravi K. Roy, Arthur T. Denzau and Thomas D. Willett 86 Post Keynesian Macroeconomics Essays in honour of Ingrid Rima Edited by Mathew Forstater, Gary Mongiovi and Steven Pressman

Post Keynesian Macroeconomics Essays in honour of Ingrid Rima

Edited by Mathew Forstater, Gary Mongiovi and Steven Pressman

First published 2007 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business This edition published in the Taylor & Francis e-Library, 2007. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2007 Selection and editorial matter, Mathew Forstater, Gary Mongiovi and Steven Pressman; individual chapters, the contributors. All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-96412-8 Master e-book ISBN ISBN10: 0-415-77231-1 (hbk) ISBN10: 0-203-96412-8 (ebk) ISBN13: 978-0-415-77231-0 (hbk) ISBN13: 978-0-203-96412-5 (ebk)

Contents

Notes on contributors 1 Ingrid Rima and Post Keynesian macroeconomics

xiii 1

STEVEN PRESSMAN

PART I

Historical antecedents 2 François Quesnay: the first Post Keynesian?

13 15

STEVEN PRESSMAN

3 Marxian economics: its philosophy, message, and contemporary relevance

33

STANLEY BOBER

4 The theoretical and political importance of the economics of Keynes: or, what would Marx and Keynes have made of the happenings of the past 30 years and more?

56

GEOFF HARCOURT

5 Profit maximization in the Cambridge tradition of economics

70

MARIA CRISTINA MARCUZZO AND ELEONORA SANFILIPPO

PART II

Post Keynesian macroeconomics 6 What is Post Keynesian economics? RICHARD P.F. HOLT

87 89

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Contents

7 Aggregate demand and supply

108

JOHN SMITHIN

8 Kaldor’s monetary thought: a contribution to a modern theory of money

129

CLAUDIO SARDONI

9 The political economy of John Kenneth Galbraith: an interpretation

147

WARREN J. SAMUELS

PART III

Post Keynesian macroeconomics in a changing world

161

10 Statics and dynamics in economic theory

163

MARK PERLMAN

11 Aggregate demand, employment and equilibrium with marginal productivity: Keynesian adjustment in the Craft Economy

177

EDWARD J. NELL

12 Corporate entrepreneurship: Schumpeter’s entrepreneurial function updated

197

LAURENCE S. MOSS

13 Saving globalization

212

JAY R. MANDLE

14 Labor markets, economic development, and job quality: Ingrid Rima’s contributions to labor economics

221

DANIEL KOSTZER

Index

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Contributors

Stanley Bober is Professor Emeritus at Duquesne University. He is the author of several books, including Capital, Distribution and Growth: A Look at NeoKeynesian Economics (University Press of America, 1980), Pricing and Growth: A Neo-Ricardian Approach (M.E. Sharpe, 1991), Recent Developments in Non-Neoclassical Economics (Ashgate, 1997), and Alternative Principles of Economics (M.E. Sharpe, 2001). Mathew Forstater is Associate Professor of Economics and Director of the Center for Full Employment and Price Stability at the University of Missouri, Kansas City. He is the co-editor of Growth, Distribution and Effective Demand: Alternatives to Economic Orthodoxy (Routledge, 2003), Reinventing Functional Finance: Transformational Growth and Full Employment (Edward Elgar, 2003), and Contemporary Post Keynesian Analysis (Edward Elgar, 2005). Geoff Harcourt is Professor Emeritus at Jesus College, Cambridge University, and serves on the Editorial Board of the Journal of Post Keynesian Economics and the Review of Political Economy. He is the author of numerous books, including Some Cambridge Controversies in the Theory of Capital (Cambridge University Press, 1972), On Political Economists and Political Economy (Routledge, 2003), and The Social Science Imperialists (Routledge, 2003). Richard P.F. Holt is Professor of Economics at Southern Oregon University. He has published a number of books, including A New Guide to Post Keynesian Economics (Routledge, 2001) and The Changing Face of Economics: Conversations with Cutting Edge Economics (University of Michigan Press, 2004). His latest book, with Steven Pressman, is Empirical Post Keynesian Economics: Looking at the Real World (M.E. Sharpe, 2006). Daniel Kostzer is Director of Macroeconomic Research and Coordination at the Ministry of Labor, Employment and Social Security of Argentina, and also a Lecturer at the University of Buenos Aires. He has served as a consultant for the International Labour Organization and the United Nations Development Program on issues related to employment and income distribution, and also

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Notes on contributors

serves as a member of the editorial committee of the journal Estudios del Trabajo of ASET (Association of Labor Studies Experts of Argentina). Jay R. Mandle is the W. Bradford Wiley Professor of Economics at Colgate University. He has published widely on economic development and Caribbean development. Mandle’s most recent book is Globalization and the Poor (Cambridge University Press, 2003). He is presently working on a book entitled United States Democracy in the Age of Globalization. Maria Cristina Marcuzzo is Professor in Economics at the University of Rome (“La Sapienza”). She is also the co-author of Ricardo and the Gold Standard (Macmillan, 1991), co-editor of Monetary Standards and Exchange Rates (Routledge, 1997), co-editor of Economists in Cambridge: A Study through their Correspondence, 1907–1946, (Routledge, 2005), and co-editor of The Economics of Joan Robinson (Routledge, 1996). Gary Mongiovi is Professor of Economics and Finance at St. John’s University. He also serves as co-editor of the Review of Political Economy. He is the editor of Macroeconomic Theory: Diversity and Convergence (Edward Elgar, 1993), Growth, Distribution and Effective Demand: Alternatives to Economic Orthodoxy (Routledge, 2003), and Sraffa and Modern Economics (Routledge, 2004). Laurence S. Moss is Professor of Economics at Babson College and editor of the American Journal of Economics and Sociology. He is also the author of Mountifort Longfield: Ireland’s First Professor of Political Economy, A Study of the Development of 19th Century Economic Theory (Green Hill Publishers, 1976); and the editor of The Economics of Ludwig von Mises: Toward a Critical Reappraisal (Sheed, Andrews and McMeel, 1976), Joseph A. Schumpeter: Historian of Economics (Routledge, 1996), and Talcott Parsons: Economic Sociologist of the 20th Century (Blackwell, 2006). Edward J. Nell is the Malcolm B. Smith Professor of Economics at the New School University. He is the author of numerous books, including (with Martin Hollis) Rational Economic Man (Cambridge University Press, 1974), Prosperity and Public Spending: Transformational Growth and the Role of the State (Unwin & Hyman, 1988), Transformational Growth and Effective Demand (Macmillan, 1992), Making Sense of a Changing Economy (Routledge, 1996), and The General Theory of Transformational Growth (Cambridge University Press, 1998). Mark Perlman was Emeritus Professor of Economics at the University of Pittsburgh before his untimely death in May 2006. He was also the founding editor of the Journal of Economic Literature, and served as editor of the journal from 1969 to 1981. His books include Labor Union Theories in America (Greenwood Press, 1976), Evolving Technology and Market Structure: Studies in Schumpeterian Economics (University of Michigan Press, 1991), Schumpeter in the History of Ideas (University of Michigan Press,

Notes on contributors

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1995), and The Character of Economic Thought (University of Michigan Press, 1996). Steven Pressman is Professor of Economics and Finance at Monmouth University in West Long Branch, NJ. He also serves as co-editor of the Review of Political Economy, and as Associate Editor and Book Review Editor of the Eastern Economic Journal. He has authored or edited a dozen books, including Quesnay’s Tableau Économique: A Critique and Reconstruction (Kelley, 1994), A New Guide to Post Keynesian Economics (Routledge, 2001), and 50 Major Economists, 2nd ed. (Routledge, 2006). Warren J. Samuels is Professor Emeritus at Michigan State University. He is also co-editor of Research in the History of Economic Thought and Methodology. His many books include The Classical Theory of Economic Policy (World Publishers, 1966), European Economics of the Early Twentieth Century (Edward Elgar, 1998), Economics, Governance and Law: Essays on Theory and Policy (Edward Elgar, 2002), Essays in the History of Economics (Routledge, 2004), and The Legal-Economic Nexus (Routledge, 2006). Eleonora Sanfilippo is a Research Fellow in the History of Economic Thought at the University of Rome “La Sapienza” and Junior Lecturer of Macroeconomics at the University of Cassino, Italy. She is also the author of Markets, Money and Capital: Hicksian Economics for the 21st Century (Cambridge University Press, forthcoming). Claudio Sardoni is Professor of Economics at the University of Rome (“La Sapienza”). He is the author of Marx and Keynes on Economic Recession: The Theory of Unemployment and Effective Demand (New York University Press, 1987). He is also on the Editorial Board of the Review of Social Economy and the Review of Political Economy. John Smithin is Professor of Economics in the Department of Economics and the Schulich School of Business, York University, Toronto, Canada. He is the author or editor of Controversies in Monetary Economics (Edward Elgar, 1994), Macroeconomic Policy and the Future of Capitalism: The Revenge of the Rentiers and the Threat to Prosperity (Edward Elgar, 1996), Money, Financial Institutions and Macroeconomics (Springer, 1997), and What is Money? (Routledge, 2000).

1

Ingrid Rima and Post Keynesian macroeconomics Steven Pressman

Post Keynesian economics developed in the latter half of the twentieth century, following publication of the General Theory (Keynes, 1964 [1936]). Some of the main figures in this endeavor were Paul Davidson, John Kenneth Galbraith, Nicholas Kaldor, Michal Kalecki, Joan Robinson, and Sidney Weintraub (see King, 2002). Their key insight was the theory of effective demand and its consequences – it is spending that drives macroeconomic performance, a monetary production economy can experience prolonged bouts of high unemployment, and economic policies are needed to assure full employment, low inflation, and stable financial markets. For Post Keynesians, the key macroeconomic problem has always been unemployment. While the mainstream views unemployment as a temporary problem that will go away in the long run if wages, prices, and interest rates were sufficiently flexible, Post Keynesians see unemployment as a problem that will not go away unless macroeconomic policies are used to create jobs. Most of the figures instrumental in developing Post Keynesian economics made this point about unemployment by focusing on aggregate macroeconomic models. These models explained how the level of output for the whole economy depended on effective demand, and how unemployment could exist, and why it would persist, whenever demand and output were insufficient. One drawback to this approach is that ignores real world labor markets. It is, of course, in the labor market that employment decisions get made and that unemployment arises when there are insufficient jobs to meet the needs of a nation’s citizens. Neoclassical economics has pointed out that sufficiently flexible markets will clear. Thus, the unemployment problem would tend to get resolved by itself if wages fell and approached the marginal productivity of workers whenever there was high unemployment. This leads to the main policy conclusion of neoclassical economics – that macroeconomic policies were irrelevant and might do more harm (generating inflation) than good. Instead, we need to make labor markets more flexible and more like the perfectly competitive markets that exist in neoclassical models. It is within this context that Ingrid Rima has made her main contribution to Post Keynesian Economics. She has examined involuntary unemployment as a result of what happens in real world labor markets. She has argued continuously

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against the neoclassical view that employment in labor markets is determined mainly by the demand for labor, which, in turn, depends on the marginal productivity of workers. And she has moved Post Keynesian economics forward by arguing that employment outcomes in labor markets are not just due to inadequate demand; they are also due to labor market institutions, history, power, and technological, sectoral, structural, and global changes. Unemployment is the result of how these myriad factors impact on labor supply and demand. Taking on the neoclassical position, Rima (1984a, 1984b, 1986b) has attempted to explicate Keynes’s notion of involuntary unemployment, and has argued that viewing unemployment as involuntary makes more sense than the job search models that have fascinated labor economists over the past three to four decades. In addition, she has attempted to bring out the neglected second strand of the economics of Keynes. Seeking to understand how labor markets actually function, and how they are related to the macroeconomy, has led logically to a concern with wages, with income distribution, and with poverty. This set of problems is what Robinson (1972) called, in her Presidential Address to the American Economic Association, “the second crisis of economic theory.” In attempting to understand and explain both unemployment and the maldistribution of income, Ingrid has brought to labor economics many of the key insights from Post Keynesian economics – the importance of history (rather than equilibrium), the use by firms of markup or cost-plus pricing over (mainly labor) costs, and the importance of wage-setting institutions (rather than marginal productivity theory) to explain wages. More importantly, following the lead of Robinson, she (Rima, 2003) has argued that the level of money wages is an historical accident that depends on the ability of workers to maintain relative wage rates. It depends on things like history, institutions, and the bargaining power of workers. This is one of the key factors that keep wages from adjusting when unemployment rates are high. But Ingrid has also brought to the analysis of unemployment and inequality her own unique perspective, one that has been neglected by both the mainstream and Post Keynesians. This analysis has focused on sectoral changes in employment, and the existence of dual labor and product markets, especially in a global economy, as main causes of unemployment and income inequality; and it has led Ingrid to call for worker training, public sector employment, and wage subsidies for the working poor (Rima, 1996, 2000b, 2003). Ingrid was born in Barmen, Germany, not far from Cologne. Around a year after her birth, her parents arrived in the United States. She grew up in Brooklyn, New York, where her father worked as a textile engineer. Both her parents stressed the importance of education, and Ingrid listened to their advice – taking the college preparatory track rather than the commercial track in high school. After high school, Ingrid did her undergraduate work at Hunter College in New York City. Besides studying dance, Ingrid took a course in price theory. As she has told Olson and Emami (2002, p. 19), she “loved all those graphs that looked so beautiful and orderly, and thought market equilibrium was quite an extraordinary phenomenon. . . . I thought that the most beautiful concepts in the world were marginal cost and marginal revenue.”

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Fortunately, her mentors at Hunter were Dorothy Lampen, author of Adam Smith’s Daughters, and Hazel Roberts, a leading scholar on the economics of Physiocrat Marshall Vauban (Olson and Emami, 2002, pp. 19–20). Lampen and Roberts introduced Ingrid to the history of economic thought. Two early figures intrigued her most – William Petty and François Quesnay (Rima, 2005). Both were physicians before they began to study economics; as such, when approaching economic questions, their instincts were to come up with solutions to the problems faced by individuals. This became the hallmark of Ingrid’s approach to economics – the economy can develop illnesses, and it is the job of the economist to understand the causes of the disease and also figure out what can be done to heal the ailing patient. Besides Petty and Quesnay, Ingrid also studied Marshall, Robinson’s (1933) Economics of Imperfect Competition, and Keynes. A careful reading of the General Theory led logically to an interest in the problem of unemployment. After graduating from Hunter in 1945, Ingrid applied to several graduate programs in economics. She chose to attend the University of Pennsylvania because it was not in New York and also not far from New York. At Penn she specialized in monetary and international theory, as well as industrial relations, the closest thing to the field of labor economics at the time. Sidney Weintraub arrived at Penn shortly after Ingrid began studying there and soon became her mentor. Weintraub sparked her interests in macroeconomics and introduced her to Post Keynesian thinking (Olson and Emami, 2002, p. 27). Her M.A. thesis was on equilibrium exchange rates. After receiving her M.A. in 1946, she was offered a research position at the Federal Reserve Bank of Philadelphia. One of her professors at Penn told her that Temple University was expanding. Ingrid applied for a job, received an offer, and accepted a teaching position there. Since 1947 she has taught at Temple University. She became an assistant professor after receiving her Ph.D. (in 1951) following the successful defense of her dissertation on public utility rate making. In 1967 she became a full professor. As Ingrid has remarked: “In a sense, 1967 is when my life as an economist began. The only date that really counts is 1967. . . . Until then nobody took me seriously (Olson and Emami, 2002, p. 24). Ingrid has certainly been taken seriously as an economist, and has also been remarkably productive as a scholar. She has served (in 1993–94) as President of the History of Economics Society. Perhaps more important, Ingrid was one of the founders of the Eastern Economic Association in 1974, and served as editor of the Eastern Economic Journal from 1979 to 1991. Besides establishing the principle that the journal would be an open forum for all perspectives in economics and all areas of specialization, she also established the practice of double-blind refereeing, something that is now common in economics but was not common when Ingrid introduced it. Several contributors to this volume (Bober, Moss, Pressman, and Smithin) were appointed to the Editorial Board of the Eastern Economic Journal and mentored by Ingrid. Two (Moss and Pressman) followed in Ingrid’s footsteps, becoming journal editors themselves.

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Ingrid’s scholarly output includes numerous books and journal articles covering a wide range of topics in labor economics, the history of economic thought, international economics, and macroeconomics. Taken as a whole, what is perhaps most remarkable about Ingrid’s scholarly work is its great range. Besides her main fields, the history of economic thought and labor economics from a global and macroeconomic perspective, she has written on poverty (Rima, 1986b, 1990), on technical change and innovation (Rima, 1989), and on the history of econometrics (Rima, 1988, 1995). Such breadth has been one of Ingrid’s greatest strengths as an economist and a scholar. Continuing her early interests in the history of economic thought, Ingrid has written extensively on Alfred Marshall, John Maynard Keynes, and Joan Robinson (Rima, 1986b, 1988, 1990, 1991, 2003). Her Development of Economic Analysis (Rima, 2000a) is one of the best-selling history of economic thought textbooks, and will soon be in its seventh edition. It has introduced tens of thousands of students to the history of economic thought. An edited volume honoring Joan Robinson (Rima, 1991) explores the important contributions of this important Post Keynesian economist. Ingrid’s essay in the Robinson volume draws attention to Robinson’s contribution to the Keynesian Revolution. She notes that “It was Robinson who pushed Keynes to recognize the revolution he precipitated stemmed from his abandoning the concept of equilibrium to move toward that of history” (Rima, 1991, p. 196). A concern with getting history right is evident in Ingrid’s work on Alfred Marshall and labor markets. Rima (1986a) makes clear that Marshall was not responsible for the conventional wisdom that remuneration to factors of production is governed by the same principles that determine commodity prices. Labor markets are thus different from other types of markets for Marshall, a position that is similar to Keynes in the General Theory and to the view that Rima has stressed throughout her career. Ingrid’s interests in the history of thought, labor economics from a macroeconomic perspective, and the real world consequences of unemployment all converge in a paper on Marshall’s view of poverty (Rima, 1990). In the second edition of the Principles, Marshall identified a growing residuum of individuals who were incapable of doing a good day’s work or earning a decent wage. Rima argues that Marshall was concerned with this residuum on humanistic as well as moral grounds, and that he was interested in developing policies to assist the poor. At an analytic level, Marshall was concerned with explaining the existence of this residuum. Rima then shows that Marshall’s inquiry into labor market peculiarities bridges the gap between his analytic and humanistic concerns. Chapters 4 through 6 (Book VI) of the Principles trace the problem of the residuum to the disadvantages of labor in wage bargaining. Poverty persists from generation to generation, according to Marshall, because nothing is done to break the cycle of poverty or improve the bargaining position of labor. This analysis has numerous linkages with Post Keynesian thought. It emphasizes history and cumulative causation rather than equilibrium, it sees wages as determined by some bargaining process rather than by worker productivity, and it

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focuses on the real world problems of poverty and income distribution. It also dovetails with the analysis of Galbraith (1958, 1964, 1979) concerning the causes of poverty in both the United States and the developing world. More recently, as globalization has become increasingly important, Ingrid has turned her attention to the global economy. The global economy is important because it changes the dynamics of the labor market (Rima, 1996, 2000b). For example, US workers in a global economy have to compete not only against other US workers with similar characteristics, expectations, and living standards, but they also must compete with workers in less developed countries. In many of these places, workers receive a good education and acquire the skills necessary to compete with US workers. They also live in places where the average living standard is one-fifth or less of US living standards, and where US laws that seek to prop up wages and demand (e.g., minimum wage laws) and establish a certain level of working conditions do not apply. For all these reasons, this leads to an exodus of jobs from the US to these less developed nations. But this movement also leaves many problems in its wake; these are all problems related to the labor market – unemployment and greater income inequality. In the spring of 1991, Ingrid organized a conference in Rome on economic restructuring that examined the causes and the consequences of globalization, and set forth policies to deal with the challenges of globalization. The two conference volumes (Rima, 1993) demonstrate both Ingrid’s breadth and her Post Keynesian orientation. The papers in these volumes address the stability in the world economy as globalization proceeds, and many papers discuss trying to how we might achieve stability and full employment in a global economy. The essays that comprise the rest of this volume all touch, and expand, on some of the main ideas and contributions of Ingrid Rima. The first four chapters, comprising Part I of this volume, make connections between Post Keynesian economics and earlier economic thinkers. Ingrid’s early interest in the work of Quesnay was noted previously. Chapter 2 traces some of the main ideas of Keynes and the Post Keynesians back to the work of François Quesnay in the eighteenth century. According to Pressman, there are several things that Quesnay and Post Keynesian economics have in common. Both developed macroeconomic models that could explain economic fluctuations and that did not result in highly desirable outcomes. Quesnay showed how it was possible that economies could continue to decline year after year, and how after years of decline there was no guarantee of greater economic growth; similarly, Keynes and the Post Keynesian showed how unemployment equilibria could persist without appropriate economic policies. In addition, both Quesnay and the Post Keynesians hold that money is not neutral in the economy, but has real economic effects. Next, both believe that investment determines savings, rather than vice versa. In addition, both Quesnay and the Post Keynesians have developed economic models which explain how demand for the goods of different economic sectors can lead to either growth or economic decline. Finally, both employ sequential models, where history is important, rather than general equilibrium models, where everything happens all at once.

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In Chapter 3, Stanley Bober discusses the importance of Marx and the relationships between Marx and Post Keynesian economics. He first considers the philosophical basis of Marx’s work and his essential message. Then he talks about the relevance of Marx in today’s global economy. Current interest in Marx, according to Bober, stems from several factors. Especially important are weaknesses in the foundation of orthodox economics, the reemergence of labor exploitation, and the continuous assault on worker rights in a global economy. Bober argues that if this revival of Marx is to be successful, it must resonate with the current political and social context. This means that Marxists need to be in the forefront of putting worker rights on the same plane with human rights, and to insist that worker rights be part of the democratic institutional arrangements that exist in every country. By focusing on the impact of free markets on labor, and the importance of political power in guaranteeing worker rights and higher labor incomes, a great deal of common ground can be found between Marxists and Post Keynesians. In Chapter 4, Geoff Harcourt expands upon this theme, and notes a number of other connections between Marx and Keynes. Both figures shared similar views of how capitalist economies work, views that differ greatly from most contemporary attempts to understand capitalism. The main difference between Marx and Keynes concerns how they viewed the economic problems that spring forth under capitalism. Keynes saw these problems as a challenge, and he sought to devise economic policies that would save capitalism and let us reap the benefits of its efficiencies without suffering from its dark side. In contrast, Marx saw these problems as signs of the inherent instability of capitalism and evidence of its ultimate demise. In Chapter 5, Maria Cristina Marcuzzo and Eleonora Sanfilippo look at the history of the notion that profit maximization guides the behavior of entrepreneurs. Marshall (1920) developed the MC  MR profit-maximizing rule for firms. Keynes (1964 [1936]) accepted this as a good short-run decision rule, as did Robinson and many others at Cambridge in the 1930s and 1940s; but Keynes stressed that investment in new plants and equipment involves a great deal of uncertainty and is not subject to this sort of calculation. As a result, the profit-maximization rule of Marshall could not hold for these long-run investment decisions. But Keynes and most Post Keynesian held that Marshall’s maximization rule operated in the short run. It is only with the work of Kalecki that short-run entrepreneurial behavior becomes dependent on customs, habits, and the opinions of other entrepreneurs. At this point in time we move from the Marshallian MC  MR approach to the Post Keynesian approach of markup or costplus pricing (see Lavoie, 2001). However, as Marcuzzo and Sanfilippo show, Robinson and Richard Kahn remained skeptical of both Kalecki’s work on pricing and the markup approach. So this did not become part of the early Post Keynesian approach to pricing. One important implication of this chapter is that Post Keynesian pricing theory may not have really begun until the mid-1970s. Only with the notion that the markup is determined by the funds needed for investment and firm growth (Harcourt and Kenyon, 1976), did the markup

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approach become generally accepted by Post Keynesians. With this doctrine Post Keynesians eschew that macroeconomics have microeconomic foundations, argue that they have given microeconomics good macrofoundations, and begin to link up what happens in macroeconomic models to what happens in labor and product markets. The second part of this book contains a set of chapters that focus on Post Keynesian macroeconomics and Post Keynesian models. In Chapter 6, Richard P.F. Holt presents the four fundamental features of Post Keynesian economics. First, there is a concern with the real world. Second, there is an emphasis on historical time. Third, Post Keynesians see the world as nonergodic, where uncertainty prevails, rather than as being ergodic and predictable. Fourth, for Post Keynesians institutions are important in determining behavior. This is true not only of the behaviour of individuals and firms; it is likewise true of the behavior of policymakers. A well-functioning economy thus not only needs good theory; it also needs competent public servants who understand this theory and who get rewarded for efficiently implementing public policies. Holt ends by questioning the Babylonian methodological approach in Post Keynesian economics, arguing that by placing a premium on accepting alternative viewpoints it takes us away from the main contributions that Keynes made in the General Theory. In Chapter 7, John Smithin examines the evolution of the concepts of aggregate demand and aggregate supply over the past seventy years. These notions were first introduced into macroeconomics by Keynes in the General Theory. Smithin argues that macroeconomics would have progressed further had the Post Keynesian model of aggregate demand and supply in Z,N space, put forward by such writers as Davidson and Smolenksy (1964) and Weintraub (1961), been more widely accepted. This would have made it easier to understand Keynes’s original concept of effective demand. In contrast, the aggregate demand/aggregate supply models, in P,Y space, that are employed in mainstream macroeconomics have evolved along different lines, and have been used to support neoclassical analysis and conclusions. Smithin then suggests an approach that, if not able to completely reconcile the existing alternatives, at least makes clear their differences and similarities. He also shows how Post Keynesian macroeconomic models can avoid the charges of logical inconsistency and theoretical error leveled at some of the mainstream constructs. His re-especified Post Keynesian aggregate demand/aggregate supply model affirms broadly Keynesian results. An increase in effective demand will tend to increase output and employment, and will do so permanently, not just for the short run. In Chapter 8, Claudio Sardoni discusses Kaldor’s theory of speculation. One important issue in Post Keynesian macroeconomics is why interest rates don’t fall to assure that savings and investment are equal, and to help the economy reach full employment. For Keynes (1964 [1936]), the answer lied in the liquidity trap and his monetary theory of interest; interest rates are determined by the supply of money and the demand for money, and there is a minimum interest rate. From this perspective, greater savings does not lower interest rates and

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generate growth through greater investment. Sardoni argues that Kaldor got similar results by following a different path. For Kaldor, the demand for liquidity involves a shift from long-term to short-term securities rather than from securities to cash. Very short-term rates are determined by the supply and demand for money, but rates on longer-term securities, which determine long-run investment decisions, depend on the willingness to undertake long-term commitments facing an uncertain future. Thus, as for Keynes, investment is determined mainly by speculative factors. But Kaldor’s analysis brings Post Keynesian macroeconomics closer to modern monetary theory, where the speculative demand for money is regarded as obsolete in a world of sophisticated financial markets, and where numerous financial instruments exist that are nearly as liquid and as safe as money. In Chapter 9, Warren J. Samuels identifies the key themes in the work of John Kenneth Galbraith. Galbraith, Samuels, and Rima all occupy a similar place in the history of economic thought. They are among the very few recent economists possessing great breadth, and interest in history as well as the social side of economics. In addition, all three share Post Keynesian perspectives about the folly of neoclassical economics and the necessity of government policy to improve economic outcomes. Galbraith accused mainstream economic theory of being a set of shibboleths adopted for the purpose of legitimizing the capitalist system and engendering complacency. But really, for Galbraith, the market was a system of social control. The question was who pulled the levers and who benefits in such a system. Because the capitalist economy was both a system of power and part of a class-dominated society, Galbraith looked to government policy to make the corporate system, the larger economy, and society less hierarchical. Like Keynes, he wanted government activism to support the needs and values that the present system ignores. One of Galbraith’s deepest and most important points, according to Samuels, is that government makes choices with every policy that it adopts on every issue. Any government is thus inevitably an activist government. The only question is which group or individual the government will support. There is thus no reason that the government should not choose to support the public purpose rather than the interests of a corporate elite. Finally, Part III of the book moves forward. The chapters in this section go beyond traditional Post Keynesian macroeconomics, exploring some of the issues that Ingrid has brought to Post Keynesian macroeconomics. As noted earlier, Ingrid always emphasized the importance of institutions, especially wage-setting institutions, in determining real world outcomes. She also viewed the economy as undergoing structural changes as it moves through historical time. In Chapter 10, Mark Perlman shows that American institutionalism had a very similar idea of economic dynamics, akin to Marshall’s partly “biological” approach in some respects, but significantly different in other respects. Perlman focuses on what he calls “the Wisconsin variant” of American institutionalism (so designated because its adherents were based at the University of Wisconsin), to which his father Selig Perlman made important contributions. What distinguishes this approach is its emphasis on synthesis over

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analytics; like Ingrid’s views on labor markets, it aims to provide an account of how the various social and institutional forces operating within an economic system helped to shape its historical development. Formal model building has its place of course, but formal model building also requires understanding the many forces that impact an economy as it develops over time. Unfortunately, Perlman argues, training in the synthesizing approach of the old institutionalists has been completely purged from the modern economics curriculum. He concludes by making a persuasive case that a truly useful economic dynamics ought to draw upon the synthesizing outlook of the institutionalists. In Chapter 11, Edward J. Nell explores a topic that has been near and dear to Ingrid’s heart – involuntary unemployment in the context of different technologies, different economic sectors, and different institutional behavior by firms. Nell contrasts craft-based or Marshallian technology with mass production technologies. In the former case, small firms employ skilled work teams, so it is hard to vary the quantity of output and employment. Here the economy will tend towards full employment. Moreover, adding more workers will tend to lead to lower additional returns, so diminishing returns operate. In this sort of economy, the real wage is likely to be equal to the marginal productivity of the worker because unemployment will lead to lower wages and more hiring. In contrast, with mass production, quantity and employment are easily changed in response to changes in demand, and the costs of production are relatively constant. In this world, employment varies but wages are not very flexible. Moreover, employment is determined by demand, which depends on consumption and investment. Consumption, the biggest component of demand, in turn, is determined by wages and employment. So even if wages do fall in a mass production economy, this would reduce spending, which would have a multiplier impact, and so not likely reduce unemployment. Chapter 12 concerns innovation, technical change, and (indirectly) sectoral change. Laurence Moss sets forth a view of innovation that depends less on individual behavior and money-making incentives, and more on relationships among individuals and corporate culture. Moss relies on Joseph Schumpeter’s distinction between management and entrepreneurship, which admits the possibility of large corporations both creating and growing new businesses. Still, it is somewhat puzzling how large firms can grow their established businesses and at the same time create new ones. Moss argues that part of the solution to this puzzle has to with “firm architecture.” Firm architecture, plus a set of shared beliefs held by top managers and division managers, gives shape to a genuinely entrepreneurial corporation. In this way the firm institutionalizes the entrepreneurial function. The institutionalization of the entrepreneurial function was described by Schumpeter, especially in his later writings, and was developed further by Galbraith (1967). Via numerous case studies, Moss shows that it is these social, institutional characteristics of firms can lead to innovation and thereby create jobs in a dynamic, global economy. As we have seen, one of the things that originally attracted Ingrid to economics was the possibility that people’s lives could be improved and that the

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negative outcomes of a capitalist economy could be mitigated. Chapter 13, the contribution by Jay R. Mandle, is written in that spirit. It argues that globalization can, and has, dramatically alleviated poverty in many Asian countries. However, because it has not been accompanied by adequate compensatory policies, globalization has worsened income distribution in the United States. Globalization, like technological change, results in both winners and losers. For globalization to benefit the entire nation, it is necessary that government policies ensure that its benefits are equitably shared over the entire population. But before the political process can provide assistance to the innocent victims of progress, the power of wealth in the US electoral process will need to be reduced. Finally, in Chapter 14, Daniel Kostzer applies Ingrid’s work on good jobs and bad jobs (Rima, 2000b) to less developed countries. He equates the informal sector of less developed countries to Ingrid’s price-taking or competitive sector, and oligopolistic sectors to Ingrid’s price-making sector. The former generally provide bad jobs (with low pay, poor working conditions, and few opportunities for advancement), while the latter generally provide good jobs (with good pay, good working conditions, and many advancement opportunities). Kostzer argues that the pro-market policies recently adopted in less developed countries, such as deregulation and opening up the domestic market to foreign competition, transform price-making firms into price-taking firms that now must compete with oligopolies from abroad. Greater competition from abroad also transforms the labor market – good domestic jobs become bad domestic jobs, to the detriment of the nation and the national economy.

References Davidson, P. and Smolensky, E. (1964) Aggregate Supply and Demand Analysis (New York: Harper & Row). Galbraith, J.K. (1958) The Affluent Society (Boston: Houghton Mifflin). Galbraith, J.K. (1964) Economic Development (Boston: Houghton Mifflin). Galbraith, J.K. (1967) The New Industrial State (Boston: Houghton Mifflin). Galbraith, J.K. (1979) The Nature of Mass Poverty (Cambridge, MA: Harvard University Press). Harcourt, G. and Kenyon, P. (1976) Pricing and the investment decision, Kyklos, 29, pp. 703–14. Keynes, J.M. (1964) [1936] The General Theory of Employment, Interest and Money (New York: Harcourt Brace). King, J. (2002) A History of Post Keynesian Economics since 1936 (Cheltenham, UK and Northampton, MA: Edward Elgar). Lavoie, M. (2001) Pricing, in R.P.F. Holt and S. Pressman (eds), A New Guide to Post Keynesian Economics (Armonk, NY: M.E. Sharpe), pp. 21–31. Marshall, A. (1920) Principles of Economics, 8th ed. (London: Macmillan). Olson, P. and Emami, Z. (2002) Engendering Economics: Conversations with Women Economists in the United States (London and New York: Routledge). Rima, I. (1984a) Involuntary unemployment and labor supply, Journal of Post Keynesian Economics, 6, pp. 540–50.

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Rima, I. (1984b) Whatever happened to the concept of involuntary unemployment?, International Journal of Social Economics, 11 (3/4), pp. 62–71. Rima, I. (1986a) The peculiarities of labor markets and the residuum, Eastern Economic Journal, 12 (2), pp. 158–74. Rima, I. (1986b) The Pigou–Keynes controversy about involuntary unemployment: a half-century reinterpretation, Eastern Economic Journal, 12 (4), pp. 467–77. Rima, I. (1988) Keynes’s vision and econometric analysis, in O. Hamouda and J. Smithin (eds), Keynes and Public Policy After Fifty Years, Vol. II (New York: New York University Press), pp. 12–22. Rima, I. (1989) The black box of technical change and innovation, Eastern Economic Journal, 15, pp. 337–9. Rima, I. (1990) Marshall’s concern about poverty: a hundredth anniversary retrospective, Review of Social Economy, 48, pp. 415–35. Rima, I. (ed.) (1991) The Joan Robinson Legacy (Armonk, NY: M.E. Sharpe). Rima, I. (ed.) (1993) The Political Economy of Economic Restructuring, 2 vols (Cheltenham, UK and Northampton, MA: Edward Elgar). Rima, I. (1995) Measurement, Quantification and the Development of Economic Analysis (London: Routledge). Rima, I. (1996) Labor Markets in a Global Economy (Armonk, NY: M.E. Sharpe). Rima, I. (2000a) Development of Economic Analysis, 6th ed. (London: Routledge). Rima, I. (2000b) Sectoral changes in employment: an eclectic perspective on “good jobs” and “poor jobs,” Review of Political Economy, 12 (2), pp. 171–90. Rima, I. (2003) From profit margins to income distribution: Joan Robinson’s odyssey from marginal productivity theory, Review of Political Economy, 15 (4), pp. 575–86. Rima, I. (2005) Interview with Ingrid Rima, Fox School of Business, Temple University, June. Robinson, J. (1933) Economics of Imperfect Competition (London: Macmillan). Robinson, J. (1972) The second crisis in economic theory, American Economic Review, 62 (2), pp. 1–10. Weintraub, S. (1961) Classical Keynesianism, Monetary Theory and the Price Level (Philadelphia: Chilton).

Part I

Historical antecedents

2

François Quesnay The first Post Keynesian?* Steven Pressman

Introduction The Presidential address that is given each year at the US History of Economics Society conference has focused frequently on the place of the history of economic thought in contemporary economics. These talks generally have bemoaned the fact that the history of thought has disappeared from the economics curriculum at both the undergraduate and the graduate levels. But they also have pointed out how the history of thought can contribute to contemporary economics, and thereby enhance its prestige in the profession. One potential contribution, identified in many Presidential addresses, is the ability to trace contemporary ideas back in history to important (or not so important) figures (see, for example, Walker, 1988; Vaughn, 1993; Moss, 1995). This chapter takes such an approach. It argues François Quesnay should be regarded as an important precursor of Post Keynesian economics. The case for this conclusion is quite straightforward. The Post Keynesian and the Physiocratic visions of how economies operate is remarkably similar; and on most important issues the economic model of Quesnay, the Tableau Économique, and the Post Keynesian macroeconomic model, are isomorphic. In what follows I examine three key areas in which Post Keynesian economics and Quesnayan economics overlap. Each is a central tenet of Post Keynesian economic analysis and each is a defining characteristic that distinguishes Post Keynesian macroeconomics from neoclassical macroeconomics. I argue that these three fundamental Post Keynesian ideas also appear in the economics of Quesnay and the Tableau Économique. First, we examine money and the nature of money. Second, we examine the relationship between savings and investment. Third, we look at issues surrounding economic prosperity and economic growth. The chapter concludes by pointing out several other parallels between Post Keynesian economics and the Physiocrats. We begin though with everyone’s favorite topic – money.

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Money Much of modern Post Keynesian analysis is about money and the macroeconomic consequences of money. There are two major strands to Post Keynesian monetary analysis. First, for Post Keynesians, the desire to hold or hoard money leads to macroeconomic problems (Davidson, 1978, 1994). In essence, for Post Keynesians, money has an impact on the real world; it is not neutral in its economic consequences. When Post Keynesians say that money is not neutral they are claiming that, contrary to neoclassical macroeconomic models, money is important in the production process (Dillard, 1948; Davidson, 1972; Lavoie, 1992; Cottrell, 1994; Wray, 2001). Money does not exist merely to facilitate exchange, with no real world effects, as in Walrasian models. Post Keynesians have spent a great deal of time and effort disputing this mainstream claim, arguing instead that money is important because it is a store of value. As a store of value, money affects the economy in several ways. In a world of perfect certainty, it would be irrational to hold money and give up interest (Davidson, 1994, p. 86). But when the future is uncertain, people may want to hold money rather than other assets and may want to hold money instead of buying goods. Money is safe, it keeps its value over time, and it gives people the security of knowing that even if things get bleak they will be able to feed, clothe, and shelter their family in the future. But this behavior has negative consequences for the economy. When people would rather hold money than buy goods or invest, no one gets hired to produce goods. As Davidson (1994, pp. 94–5) notes, money has a zero or negligible elasticity of production in addition to the fact that there is a zero or negative elasticity of substitution for liquidity. What this means is that the demand for money rather than goods does not create a demand for production or a demand for labor. The result is low or negative growth rates and high rates of unemployment. Post Keynesians have also argued against the monetarist view that money is neutral because it affects the price level and rate of inflation rather than production and the level of employment. Given the equation of exchange, MV  PQ, an assumed constant velocity (V) and constant growth of real GDP (Q) in the long run, there must be a relatively fixed relationship between money growth and the growth of the price level (or inflation). Friedman (1968b) argued that this was a causal relationship going from changes in the money supply to changes in the price level. His famous remark that “inflation is always and everywhere a monetary phenomenon” (Friedman, 1968a, p. 106) captures the nature of this causal relationship between money and inflation. The monetarist policy solution of holding money growth steady follows simply and directly from this analysis. The Post Keynesian view of money grew out of an opposition to monetarists advocating tight money and high interest rates as a solution to the problem of inflation. Nicholas Kaldor (1970, p. 12; 1982) pointed out that V might not be

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constant, and so changes in the money supply might affect real output. Tight monetary policy then would slow down economic growth and create unemployment but would not affect the price level or the rate of inflation. Kaldor also advanced the doctrine that the money supply was actually endogenous (more on this below); that is, the supply of money was determined by what was going on in the macroeconomy rather than by some outside force like the national central bank. Reversing Friedman’s causal sequence, for Kaldor and most Post Keynesians, it is changes in Q that cause changes in M. Again, the result is that tight monetary policy is not a viable anti-inflation policy. Quesnay did not concern himself with notions of uncertainty. Part of the reason for this is that he was writing before economic analysis made assumptions about individual decision-making and the rationality of individual agents. Another part of the reason for this is that Quesnay was really a macroeconomist and so he was interested in the behavior of large numbers of people rather than the behavior of particular individuals. If anything, Quesnay had an institutional or habitual theory of individual behavior – another similarity with much of Post Keynesian economics (see Pressman, 2003). This is most obvious and striking in his usual assumption that the spending propensities of the agricultural (productive) sector and the manufacturing (sterile) sector were the same as the proprietors. The proprietors set the standards for the nation; others followed like lemmings to the sea. It is also apparent in his assumption that, according to tradition, at the end of each production cycle the entire net product always gets paid to the proprietary class (see Pressman, 1994, pp. 9–11, 18–19). Nonetheless, even without the notion of uncertainty underlying individual behavior, Quesnay held that money was important because it had real world consequences – the desire to hoard and not spend money leads to economic stagnation. Thus, like the Post Keynesians, money for Quesnay has negative real world consequences when it was hoarded. Even before he developed his mathematical model of the economy that is embedded in the Tableau, Quesnay saw that hoarding money would lead to economic decline. In the early Encyclopedia article “Corn,” for example, Quesnay writes about the importance that revenues be spent so that that they circulate throughout the economy (Meek, 1963, p. 76). And his Encyclopedia article “Men” claims that spent revenues increase the nation’s revenues and population (Meek, 1963, p. 88). But Quesnay was not able to demonstrate this claim until he developed his model showing how the macroeconomy operates and the macroeconomic consequences of hoarding money. In the static versions of the Tableau, where output gets reproduced without increase or decrease, Quesnay always assumed no savings or no hoarding of money received as income. This is true of the revenues going to the two producing classes via the zig-zags of the Tableau (Meek, 1963, p. 109) and also true of the revenues received by the proprietary class (which includes the government). This means that simple reproduction, reproduction without growth, required that there be no hoarding of money. This assumption underlies all versions of the static Tableau, and thus was a

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necessary condition for simple reproduction to take place. It is stated in the marginal notes that accompany every existing version of the Tableau. These notes describe the assumptions underlying its construction and operation. For example, in Remark 1 of the first version of the Tableau, Quesnay assumes that revenues are “never formed into monetary fortunes, which check the flow of part of this annual revenue of a nation” (Meek, 1963, p. 109). Remark 5 reinforces this and holds that it is true of the proprietary class (Meek, 1963, p. 112). Remark 6 holds that this is also true of the taxes collected by the government, which Quesnay included in the proprietary class as one of his simplifying assumptions. Tax collections that do not get spent do not enable reproduction to continue as before, and result in economic decline. So static reproduction requires that the government never accumulate “monetary fortunes” (Meek, 1963, p. 112) or, in modern parlance, the government never runs a budget surplus. When Quesnay developed a dynamic version of the Tableau, showing economic growth and decline, the message is even clearer that hoarding money leads to economic decline. In L’Ami des Hommes, Quesnay argues that, contrary to the mercantilists, accumulating monetary fortunes will not contribute to the wealth of a nation. Rather, monetary fortunes only contribute to economic growth if they are spent. If saved and accumulated, according to Quesnay, money impoverishes a nation (Mirabeau and Quesnay, 1762, Vol. 5, p. 93). Thus, for Quesnay, like the Post Keynesians, money has real world effects. When money is hoarded rather than spent, the economy stagnates; when money is spent, the economy can reproduce itself each year. While Quesnay did not talk about unemployment, and while unemployment is difficult to conceptualize in the sort of feudal, agrarian economy that Quesnay attempted to model and understand, we can still talk about the consequences of these changes on the labor market given our knowledge of economic principles, how Quesnay conceptualized the economy, and the nature of the French economy in the mid-eighteenth century. Since, for Quesnay, goods are necessary to support people during the year when they are producing next year’s stock of goods, reduced production in any one year will lead to a lower population. Quesnay (Meek, 1963, p. 256; Pressman, 1994, pp. 99–100) at points talks about the possibility of immigration to deal with the short-run needs for more workers in a growing economy. By extension, we can suppose that he thought about the possibility of emigration to deal with the problem of insufficient food to nourish the existing population. But Quesnay also seemed to recognize the classical Malthusian mechanisms of starvation and “other vices” as a means of dealing with a redundant labor force in the long run (see Meek, 1963, p. 67). A second major tenet of Post Keynesian monetary theory is that money is endogenous. In fact, probably nothing defines the Post Keynesian approach more than the belief that money is endogenous. Money is endogenous for Post Keynesians because it is created by bank loans. When businesses come to banks for loans, banks are usually willing to grant the loan request because they want to maintain good relations with business firm and because bank profits come

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from lending money. This idea originally came from Keynes’s (1937) discussion of the finance motive, or firm demand for money to finance new investment. Financial innovations will allow banks to make loans even in the face of tight monetary policy by the central bank. But, also, the central bank will likely accommodate the increased demand for money by firms and the increased desire to lend by banks (Moore, 1988). Since firm demand for loans is a function of economic conditions, the supply of money becomes endogenous and outside the control of monetary authorities. Furthermore, the endogenous nature of money supports the Post Keynesian causal sequence whereby changes in prices cause changes in the money supply. In times of inflation, firms will face higher labor costs and higher material and part costs. To continue production in an inflationary era, firms will need to borrow more money, and banks will likely find a way to lend them the money they need through various forms of financial innovation. But such borrowing creates more money. This reverses the causal sequence of the monetarists – inflationary pressures result in greater money demand. Banks and central banks are generally accommodating and so the money supply is not controlled by some outside independent force (like a central bank), but is the end result of pressures within the economic system. Money was also endogenous for Quesnay and the Physiocrats, although there are many differences in the nature of the economy today and the economy of eighteenth-century France that Quesnay was seeking to understand. When Quesnay was writing, money was commodity money (precious metals) rather than bank money. Also, for Quesnay money was not endogenous because of the behavior of banks and central banks. There were just more than 50 banks in France in the early eighteenth century (Vilar, 1969, p. 275), but these banks mainly bought and sold private trading notes and so were more like brokerage firms than financial intermediaries that channeled savings to investment and increased the money supply. In addition, when Quesnay was developing the Tableau in the mid-eighteenth century, France had no central bank and the modern tools of central banking were not employed. It was not until March 1776 that Turgot established the first discount bank in France, which traded precious metals and which lent money to banks. But as Vilar (1969, p. 279) notes, this was “in no way a national bank” and was not similar to what we now recognize as central banks. Yet, despite these major institutional differences, the Tableau Économique contains within it the notion of endogenous money. In a pre-capitalist and pre-industrial economy, where precious metals constituted the money supply, there are two general ways the money supply can grow. First, the money supply can be exogenous, or grow for reasons outside the economic system. One reason could be the discovery of large stocks of gold and precious metals. Another reason could be political decisions to print and circulate money, or what was more typical, to reduce the gold content in coins (Vilar, 1969). These solutions involve someone or something outside the economic system bringing more money into circulation. But a second possibility is that the supply of money grows as a result of the

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economic system itself growing. For this to happen, it is necessary that money flows to those areas experiencing economic growth. Growing economies thus attract gold while declining economies lose gold. This view is consistent with the mercantilist position that the government should stimulate growth in order to attract wealth or precious metals to the country. Both Cantillon and Hume, in developing the specie flow mechanism, accepted the mercantilist analysis of how economic growth generates more money; but Hume (1955, pp. 60–77), like the mercantilists and modern-day monetarists, argued that the additional money would increase prices and bring growth to an end. Quesnay accepted much of this analysis by Cantillon and Hume, but he held a position closer to the Post Keynesian view because he focused on quantity adjustments due to more money rather than price adjustments and because he did not hold that there was a natural termination to the growth process, or an equilibrium point that the growth process would tend to converge towards (more on this latter point below). One problem interpreting the Tableau has always been the issue of money and whether there would be sufficient money in the economy to facilitate trade and reproduction. Money is important in the Tableau because all reproduction cycles begin with the landowner class being paid the agricultural surplus from the previous year (or production period) in the form of cash. In the static zig-zag Tableau, these cash payment always equal the sum of the entire amount of money circulating in the economy. Production and distribution cycles begin with the landowners spending this money on manufactured and agricultural goods. Quesnay did not worry about the question of the actual supply of money until the third edition of the Tableau. There he calculates for the first time that the amount of money necessary for simple reproduction was equal to the agricultural net product, or the annual economic surplus. If the supply of money was greater than the net product, the extra money would be exchanged for goods produced abroad (Kuczynski and Meek, 1972, p. x). Quesnay was silent about the contrary case, where the supply of money was less was less than the net product. But it is possible to deduce the consequences of insufficient money from our knowledge of the workings of the Tableau. In the dynamic versions of the Tableau, Quesnay shows the consequences of economic growth, and he describes the causes of economic growth and decline. Economic growth entails the growth of the agricultural sector, and so a greater agricultural surplus. The money value of this surplus must be paid to the proprietors at the beginning of the next production cycle. But where does this extra money come from? As I have argued elsewhere (Pressman, 1994, Chapter 4) the additional money comes from a trade surplus that occurs when economies grow and prosper, and that Quesnay assumed would result when constructing his economic model. Free trade, he thought, would result in France exporting grains because France would become more productive in agriculture than England and other countries. Free trade would also let France sell to a bigger market and allow French agriculture to use more advanced techniques of production in the agricultural sector. These French exports of grain would result in a trade surplus. In return for these goods, France would obtain gold and other precious metals

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from abroad. This addition to the national stock of money would get paid to the proprietors as rents at the beginning the next production period, and thus would sustain higher levels of output in future production periods. To summarize, Quesnay and Post Keynesian economics hold two important propositions in common regarding money and the nature of money. First, for both schools of thought, money has real world consequences – it affects production and it affects economic growth. Second, for both schools of thought, money is endogenous rather than exogenous. For these reasons, the economics of Quesnay should be regarded as an important precursor to Post Keynesian monetary economics.

Savings and investment Perhaps the greatest difference between Post Keynesian and non-Post Keynesian macroeconomists concerns the nexus between savings and investment. One can almost define a Post Keynesian macroeconomist as someone who believes that investment causes savings and that increases in savings will not lead to increases in investment. This position, usually referred to as “the theory of effective demand,” is probably the main theoretical edifice of the Post Keynesian approach (Hamouda and Harcourt, 1988; Arestis, 1996). In a simple economy, with neither a government sector nor a foreign sector, it must always be the case that savings will equal investment. In the more complex cases, savings does not have to equal investment; the two can diverge from each other based on the size of the government budget deficit (or surplus) and the trade budget deficit (or surplus). Nonetheless, there will always be fixed relationship between savings and investment as determined by these two other categories of expenditure. This is not a matter of great dispute; in fact, it is a matter of mathematical necessity. The key question in macroeconomics is the causality between these two variables. Does savings determine investment or does investment determine savings? One hallmark of neoclassical macroeconomics is the belief that greater savings leads to greater investment. This is a specific application of Say’s Law – the supply of savings automatically leads to a demand for that savings to finance business expansion. But Say’s Law is not compatible with the Keynesian and Post Keynesian theory of effective demand, which holds that it is actual spending which determines the level of output. As Mongiovi (1990, p. 77) succinctly puts it: “Say’s Law asserts that any level of output which is produced will be sold, whereas the theory of effective demand claims that the economy will tend to produce that level of output which can be sold.” Adam Smith (1936, pp. 321–2) held something similar to Say’s Law when he wrote in The Wealth of Nations that Whatever a person saves from his revenue he adds to his capital, and either employs it himself in maintaining an additional number of productive

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S. Pressman hands, or enables some other person to do so, by lending it to him for an interest, that is, for a share of profits. . . . What is annually saved is as regularly consumed as what is annually spent, . . . but it is consumed by a different set of people.

Malthus (1964 [1820], pp. 401ff.), however, did not think that savings would be inevitably converted into capital, and that this would lead to periodic depressions or gluts. Part of the problem was that capitalists received much more income than they could possibly spend or invest. Keynes (1951, p. 103) made complimentary comments about Malthus and attributed to him the discovery of the principle of effective demand. Following Malthus, Keynes did not think that an increase in savings would lead to increased investment. As pointed out by Asimakopulos (1983), in his essays following the General Theory, Keynes distinguished the notion of “finance” from the notion of “savings.” Finance involves the ability of banks to lend out money and create money. It requires no savings, only the power of banks to generate liquidity. This breaks the link between savings and investment and opens the door for a reverse causal sequence – one going from investment to savings. Post Keynesians have followed Malthus and Keynes, and have argued that more investment causes more savings but more savings does not cause more investment (Moore, 1978, p. 128). Joan Robinson (1962, pp. 82–3), for example, noted that “the central message of the General Theory was that the rate of savings of the economy as a whole accommodates itself to the rate of investment.” As the economy grows, due to multiplier and accelerator effects, whenever there is greater investment spending, some of the additional income will be saved. It is this mechanism which assures the equality of savings and investment. In contrast, greater savings slows down growth and ultimately reduces incomes and savings – Keynes’s (1964 [1936], p. 373) famous paradox of thrift. The modern solution to this problem is to have the goods that are not consumed go immediately to additional investment, and to have interest rates serve as the mechanism to insure that all savings wind up as investment. But, Keynes and the Post Keynesians have disputed that such a mechanism operates in the real world. Savings does not immediately get converted into investment. What is saved does not purchase goods and services. These goods pile up as inventories and are essentially a form of waste. At the very least, they reduce business profits and the willingness to invest. For Post Keynesians, expectations and profits affect investment. That is why an increase in savings does not lead to an increase in investment. The loss of sales lowers profits and worsens expectations about future profits. The attempt to save more ex ante is frustrated; and because of slow growth and low incomes, the savings rate falls, leading to no additional savings ex post. Quesnay was also clear that greater savings hindered economic performance, and that an increase in savings would not lead to greater investment. In fact, the reverse was true for Quesnay – greater consumption led to greater investment in

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the agricultural sector (a sort of accelerator effect). Contrary to the mercantilists, whom Quesnay was writing against, Quesnay argues that accumulating savings does not contribute to the wealth of nations. Money only contributes to economic growth if it is spent. Money that is accumulated impoverishes a nation (Mirabeau and Quesnay, 1762, Vol. 5, p. 93). While Quesnay recognized that saving would lead to economic decline and that the static Tableau required the assumption of no savings, nowhere does he attempt to demonstrate these results. There is no known Tableau analyzing the effects of hoarding on the economy. Even in L’Ami des Hommes, where Mirabeau and Quesnay (1762, Vol. 5, pp. 92–101) describe in detail the effects of hoarding, they fail to demonstrate the effects of hoarding by means of a series of Tableaux. Pressman (1994, pp. 136–42) filled this gap by showing how, according to all the main principles of the Tableaux, savings should result in economic decline according to Quesnay. Pressman sets forward two Tableaux in the spirit of Quesnay, which show the economic effects of savings – one showing the impact of proprietor savings and the other the effect of savings by the two producing classes. The mechanics of the model, in brief, are as follows. No matter who does the saving, the money that does not get spent is money that does not purchase goods. This results in goods remaining unsold. In Quesnay’s classical model of the production of commodities by commodities, unsold goods will perish. These goods, therefore, do not get used in the next period’s production process and so output will be lower in the following period. This lower output results in a smaller surplus. So in subsequent economic periods, the proprietors will receive less income, will spend less money, and so the economy will continue to operate at this lower level of production. This decline will be even worse if there is also savings in subsequent economic periods. This decline would hinder new investment and the adoption of new techniques of production. Agricultural productivity would thus stagnate and the economy would not grow. In contrast, increased spending by the proprietors and/or by the two producing classes would lead to the adoption of more advanced agricultural techniques, improved productivity growth, and greater economic growth in the future. Again, the contrast between Quesnay and other classical economists is remarkable. For the mercantilists, savings was wealth; and when money was not spent on foreign goods this meant that national wealth increased. For Smith, and most classical economists, savings was seen as virtuous and was thought to be immediately transformed into demand for investment goods. Not so for Quesnay. But with the exception of Malthus, this idea disappeared until revived by Keynes. Although historians of thought, and even Keynes himself, traces the origin of his ideas on the economic impact of saving back to Malthus, the real historical origin of this Post Keynesian position lies in the economics of Quesnay. Quesnay developed the first model where effective demand was important. It was the spending propensities of everyone that determined the levels of production and output; and it was spending that led to more investment.

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When it comes to macroeconomics, one can distinguish two camps or approaches. One approach, beginning with Adam Smith and relying on Say’s Law, progressing through Marshall and then going on to standard macroeconomics (which includes neoclassical synthesis Keynesian, monetarist, and new classical versions), sees output levels determined mainly by savings and supply-side factors. A second approach, pioneered by Keynes and adopted by Post Keynesian macroeconomists, sees levels of output determined mainly by investment and spending. Keynes added Malthus as an important precursor of this approach to macroeconomics. This section has argued that Quesnay deserves attention, not only as an important advocate of the theory of effective demand, but as one of the first major exponents of this doctrine in the history of economic thought.

Prosperity and growth Two issues are prominent in any macroeconomic approach to understanding the economy. First, will the economic system tend to stabilize at high levels of output and employment? Second, there is the matter of what determines longrun economic growth. On these two questions, Quesnay and the Post Keynesians give similar answers. Both see the economy as likely to produce low levels of output for extended periods of time; and both see long-run growth determined by quite similar mechanisms. One of the hallmarks of modern Post Keynesian macroeconomics is the argument that economies can be stuck in a less than full-employment equilibrium, and that full-employment can usually be reached only by the effective use of macroeconomic policies (see Holt and Pressman, 2001). Keynes attempted to explain the possibility of less than full employment equilibrium in the General Theory (1964 [1936]). Unlike neoclassical macroeconomic models, Post Keynesians do not see interest rates as equilibrating savings and investment, thereby leading to more spending and growth when demand is inadequate. Rather, they see investment as determined more by expectations or “animal spirits” (Rosser, 2001). When firms are unwilling to invest because of an uncertain future and/or bad expectations, economies remain mired in recession or depression. Following Myrdal (1957), Post Keynesians see the possibility of circular and cumulative causation operating in the economy to keep it there, rather than seeing forces moving the economy to some equilibrium position at or near full employment. Kaldor (1985), for example, focused attention on developing “Economics without Equilibrium,” meaning that the economy should be viewed as a growth process with no mechanism tending to establish full employment or no equilibrium growth rate that would assure full employment. And Joan Robinson (1980) stressed that history was more important than equilibrium. This has become a guiding metaphor and mode of analysis for Post Keynesian economics. Because history is so important, a bad economy creates expectations of continued bad times; it inhibits additional investment and causes worker skills to deteriorate. All of this tends to keep economies stuck at a point where high levels of unemployment prevail.

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Likewise, for Quesnay, an economy can remain mired in a state of decline without some mechanism pulling it back to full employment or a higher growth path. This was the main point of his dynamic Tableaux. These models showed a continuous growth of the French economy for extended periods of time, or continual stagnation of the French economy whenever inappropriate behaviors or policies were hurting the economy (see Pressman, 1994, Chapter 2). Quesnay (1764, Vol. II, pp. 141ff.) was especially concerned about the French economy being stuck at some point with low levels of production for a long period of time. His Tableau was designed to show that these low levels of output could exist and could continue to exist. Quesnay identified a number of factors could lead to continued growth or continued decline – bad tax policy or excessive government regulations, hoarding or saving, too much spending on the goods of the less productive sector, the use of outdated techniques of production in agriculture, or disasters that spoil agricultural sector inputs. While there were many possible causes of economic decline, there is no mechanism that Quesnay recognized that would naturally put the economy on a stable growth path. However, there were economic policies that could help put the economy on this path. For example, Quesnay stressed the importance of appropriate tax policy and a fiscal policy that included no government hoarding or budget surpluses. The Physiocrats also advocated more spending on agricultural goods. Several Tableaux were set forth by Quesnay to show that the excessive consumption of luxury manufactured goods results in economic decline for the entire nation. These appear in both L’Ami des Hommes (Mirabeau and Quesnay, 1762) and in Philosophie Rurale (Quesnay, 1764). In contrast, another set of Tableaux was designed to show that greater consumption of agricultural goods would spark economic growth. Pressman (1994, pp. 36–9) and Meek (1963, pp. 287ff.) present some of the actual Tableaux that Quesnay set forth to make his case. These models are all about how spending propensities toward different economic sectors generate different sets of economic outcomes. In none of these cases is there a tendency to move toward some position of full employment or to some stable situation. A second issue concerns the causes of growth. Most neoclassical models are generally models of steady-state growth, where demand adjusts automatically to increases in supply or productive capacity. Long-run growth is thus determined by supply constraints – too few resources are available or resources are being used inefficiently. Post Keynesians, in contrast, see growth as being demand-led. As Setterfield (2001, p. 95) notes, in the Post Keynesian approach to growth, demand is the key. Demand is important for two reasons. First, demand influences the utilization of productive resources. Second, demand affects the ability to produce goods in the future and thus future living standards. Demand increases laborforce participation which increases output and makes firms more willing to adopt new technologies, thereby giving rise to dynamic increasing returns. A second aspect of Post Keynesian growth theory concerns the real-world

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forces that stimulate economic growth. Since growth for Post Keynesians is a path-dependent process, we need to know what puts us on a good growth path and what keeps us off a bad growth path. Thirlwall (1983, 1987) has identified three growth laws associated with the work of Kaldor (1967). These laws provide the foundation of Post Keynesian growth theory. As we shall see, these are the same growth laws, and they employ the same mechanisms or analytics as the Tableau. Kaldor’s first law, as expressed in equation (1), states that the growth of output (gGDP) is a function of the growth of manufacturing (gM), or that the manufacturing sector is the engine of growth for the whole economy. gGDP  a0  a1(gM)

(1)

Kaldor estimated a cross-section regression for 12 developed countries over the period from the early 1950s to the early 1960s. His finding of a strong correlation (R2  0.96), and a regression coefficient, a1, that was less than 1 shows that for the whole economy to grow it is necessary for manufacturing to grow. Kaldor did not find similar relationships between the growth of output overall and the growth of agriculture. He, alas, did not test for the growth of the service sector. Kaldor reasoned that sectors growing faster than the whole economy were spurring growth elsewhere, while sectors growing less than average were slowing overall growth. Several mechanisms can help explain this phenomenon according to Kaldor. Probably most important, is Kaldor’s second growth law, commonly referred to as “Verdoon’s Law,” which holds that faster growth in manufacturing leads to faster growth of labor productivity in manufacturing (pM). Conversely, Kaldor (1996, p. 72) argued that lower productivity is due to reduced sales. Essentially, there are increasing returns in manufacturing. Formally, pM  b0  b1(gM).

(2)

Kaldor got the idea of increasing returns from Allin Young (1928). By most accounts, Young found the notion of increasing returns at the beginning of The Wealth of Nations (Smith, 1936). In the legendary pin factory of Adam Smith, whenever sales increase, firms can divide up tasks and by so doing increase the productivity of each worker. Workers can specialize in particular aspects of the whole job and thus gain skills and expertise at performing these tasks. They also do not waste time moving from one job task to the next. As we shall see in a moment, the idea of increasing returns really goes back to Quesnay’s case for developing the agricultural sector of the French economy. Moreover, Charles Blitch (1995, pp. 145–6) reports that Young was familiar with the work of Quesnay as well as with Smith, and that Young had even read Quesnay. The historical lineage of this idea thus becomes Quesnay and Smith to Young and the Post Keynesians. Finally, Kaldor’s third growth law concerns labor resources moving to manu-

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facturing from other economic sectors, where they are essentially unemployed. Equation (3) states the mechanism of labor transfer. Faster manufacturing sector growth attracts labor from other economic sectors where they are essentially unemployed or at least underemployed. gGDP  c0  c1(eM)

(3)

To test this hypothesis, Kaldor (1967) regressed manufacturing employment growth and output growth, and found a strong positive relationship. The regression coefficient c1 was positive and statistically significant. Moreover, there was a high R-squared value for the regression. Adding employment growth outside manufacturing (eNM) to the model, Kaldor found little change in the manufacturing employment regression coefficient, while the non-manufacturing employment growth coefficient was negative and not statistically significant. Kaldor concluded from this that growth in the manufacturing sector stimulates overall economic growth or that manufacturing is the engine of growth for the economy; the growth of other economic sectors do not have the same economic impact. Remarkably, Quesnay’s analysis of economic growth was essentially the same as that of the Post Keynesians. Pressman (1994, Chapter 4) explains the mechanisms underlying economic growth and decline in the Tableau, and argues that the main mechanisms required to make the Tableau consistent and coherent were explicit or implicit in the writings of Quesnay. He focuses on the cases where spending favors the agricultural sector and where spending favors the manufacturing sector. When spending propensities favor the agricultural sector, the French economy would grow and prosper. In contrast, when spending propensities favored the manufacturing or sterile sector, the economy would decline. Pressman (1994, Chapter 4) identifies two important mechanisms that are required to make the Tableau work, and argues that they are found in Quesnay and classical economics. First, there was population mechanism. According to this, when demand for the output of one sector increased, resources would move to that economic sector. When resources moved to the more productive sector, they yielded greater output and enabled the economy to grow. More individuals could be supported by the increased output and more input were available for next year’s or next period’s production. In contrast, when resources moved to the less productive sector, less output would be produced and the national surplus would shrink. This reduced production in both economic sectors in future production periods. Second, there is a productivity mechanism. Greater demand for agricultural goods allowed the use of more advanced techniques in agriculture and raised agricultural productivity. Inputs came to yield greater output or a bigger surplus in the agricultural sector. From this we may set forth the following formal growth laws in the work of Quesnay. These laws parallel the growth laws of Kaldor and the Post

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Keynesians. First, for Quesnay, the growth of output (gGDP) is a function of the growth of the agricultural sector, gA. This depends on the demand for agricultural goods, or the spending propensities for the goods made by the productive sector of the economy. Thus, the growth of the agricultural sector drives overall economic growth. gGDP  a0  a1(gA)

(1)

Second, for Quesnay, the growth of agriculture allows the use of more advanced techniques for producing agricultural goods. This increases the agricultural surplus, or the productivity of workers in the agricultural sector. The same amount of labor or the same quantity of inputs (used to feed and clothe workers and used as seed to grow more food) now produces more agricultural goods. Equation (2) expresses this relationship. pA  b0  b1(gA)

(2)

Finally, the more output produced, the greater the number of workers could be supported in the agricultural sector, and more workers will be attracted to the agricultural sector from the manufacturing or sterile sector. This relation is expressed in equation (3): gGDP  c0  c1(eA)

(3)

Moreover, Quesnay thought that employment growth in the non-productive or less productive manufacturing sector would slow down economic growth because workers employed in manufacturing create no surplus. Thus the movement of workers from agriculture to manufacturing results in some loss of the national surplus, which is part of national output. Expressed in this form, it is relatively easy to see that these three growth laws are essentially the same as the growth laws of Kaldor. (These parallels are discussed in more detail in Pressman, 1993.) The obvious difference between Kaldorian and Quesnayan growth concerns which sector is the (more) productive sector. In Quesnay’s time, of course, with little manufacturing and most of the manufacturing being small scale and done at home, it is not surprising that he would see agriculture as the more productive and dynamic economic area. In contrast, Kaldor wrote about economic growth in the middle of the twentieth century when increased manufacturing efficiency through mass production and through robotics was increasing everyone’s living standard by large amounts. Thus it is not surprising which sector Kaldor chose as more productive. Yet behind this difference, the two sets of growth laws that are isomorphic. Both Kaldor and Quesnay saw economic growth as a cumulative sequence whereby the extension of markets led to improvements in productivity growth leading to an expansion of economic demand and further improvements in

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productivity growth. For Quesnay, greater spending on agricultural goods leads to growth because of the movement of labor to the agricultural sector and because of improvements in productivity growth in agriculture. For Kaldor, more demand for manufactured goods moves resources to this sector and contributes to growth because of increasing returns to scale. Not surprisingly, these very similar economic models also lead to similar policy conclusions. The Physiocrats argued for policies that would help develop France’s agricultural sector. They did this by advocating reduced taxes and other burdens on the agricultural sector, and arguing for reduced trade restrictions so the agricultural goods could be more easily exported and, with a greater demand for them, obtain higher prices. In contrast, Post Keynesians have advanced policies that seek to increase exports of manufactured goods and thereby generate export-led growth such as tax breaks, regulatory reforms, and other forms of government assistance to manufacturing firms (Kaldor, 1967, p. 42; Crane, 1981). Kaldor (1966, Chapter 7) also argued for a selected employment tax that would fall on non-manufacturing employment. While discouraging employment in non-manufacturing sectors, this would improve the relative position of the manufacturing sector and would provide economic incentives for manufacturing firms to expand and hire more workers.

Summary and conclusions The main argument of this chapter has been that in three important respects Post Keynesian economic ideas can be traced back to the Physiocrats and François Quesnay. These were (1) the endogenous nature of money, and the fact that money has real economic effects; (2) a rudimentary theory of effective demand – the fact that greater savings does not cause greater investment and economic growth, but rather it is spending that generates investment and growth; and (3) an analysis of economic stability and growth that relies on identifying a dynamic economic sector and explaining how demand for the goods of this sector set in motion a cumulative process of economic growth. Several additional parallels between Post Keynesian thought and Quesnay’s economics are worth mentioning briefly. As Meek (1963, p. 293) pointed out, there are affinities between the zig-zags of the Tableau and the Keynesian multiplier. Both show that “the expenditure of one man’s income generates income for another,” and so spending by others. In turn, these expenditures all affect national output and economic growth. Also, as noted earlier in the chapter, both Post Keynesians and Quesnay held an institutional or habitual view of behavior. Both approaches are truly macroeconomic and see individual behavior as determined by macro foundations or phenomena, rather than vice versa. Then there is the belief that economic analysis should employ the notion of historical time rather than logical time. Logical time is assumed in neoclassical general equilibrium models. It is the foundation of Walrasian models, where a set of equilibrium prices must be established before any trade takes place. In contrast, historical time is irreversible. If the Walrasian auctioneer gets prices

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wrong at one time we do not get a do-over; we cannot go backward in time to redo it all until it turns out right. Real economic life is not at all like the predicament of Bill Murray in the movie Groundhog Day. We cannot recontract our lives and make important (and not so important) decisions over and over until we get it right. Davidson (1972), Robinson (1980), and others have emphasized the importance of historical time and its importance in the real world and for Post Keynesian analysis. For Quesnay, historical time was also important. His model was a sequential model and not a neoclassical, Walrasian model of general equilibrium (see Eltis, 1998). Economic transactions and relations had to follow a particular sequence, or reproduction could not and would not occur (Pressman, 1996, pp. 225–6). The Tableau was thus a model recognizing the importance of historical time. For all these reasons, Quesnay should be regarded as the first Post Keynesian. Moreover, Post Keynesians should be encouraged to trace their lineage back to this path-breaking French economist. Finally, perhaps “Post Keynesian economics” should be mispronounced (like “Keynes” is frequently mispronounced) and called “Post Quesnayan economics.”

Note * An earlier version of this chapter was presented as a paper at the 2003 UK History of Economic Thought conference. The author thanks the participants at the session where this paper was presented for their helpful comments, especially Anthony Brewer and Geoff Harcourt.

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Marxian economics Its philosophy, message, and contemporary relevance Stanley Bober

The philosophy Marxian economics relies on a particular philosophy for understanding human behavior and the structures and development of society. This philosophical construction is now widely understood as the materialistic (economic) interpretation of history, which asserts the primacy of economic arrangements, or the mode of production, in conditioning the social consciousness of people in their relationship with each other. The materialist interpretation of history is described by Karl Marx ([1971] 1859, p. 1) as follows: My inquiry led me to the conclusion that neither legal relations nor political forms could be comprehended whether by themselves or on the basis of a socalled general development of the human mind, but that on the contrary, they originate in the material conditions of life the totality of which Hegel, following the example of English and French thinkers of the eighteenth century, embraced within the term “civil society”; that the anatomy of this civil society, however, has to be sought in political economy. The general conclusions at which I arrived and which, once reached, become the guiding principle of my studies can be summarized as follows. In the social production of their existence, men inevitably enter into definite relations, which are independent of their will, namely relations of production appropriate to a given stage in the development of their material forces of production. The totality of these relations of production constitutes the economic structure of society, the real foundation, on which arises a legal and political superstructure, and to which correspond definite forms of social consciousness. The mode of production of material life conditions the general process of social, political and intellectual life. It is not the consciousness of men that determine their existence, but their social existence that determines their consciousness. There are two terms to highlight in this revealing passage. The first is “political economy,” which may be defined as the economic laws of motion that drive the behavior of individuals regarding the production and distribution of the national output, and that result in increasing the productive capability of society.

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For Marx, these laws of motion stem from men’s consciousness. They are formed by the conditions of production operating in some historical time. Other than, perhaps, the rule of force, there are no trans-historical natural laws that govern the behavior of men and ensure the prevailing mode of production continues. The philosopher Isaiah Berlin (2004) makes the following telling observation about natural law and Marx when he says: I believe that there are thinkers, principally believers in Natural Law, who propose that all men are created, whether by God or Nature, endowed with innate knowledge of certain truths – some “factual” some normative – the lists differ from Aristotle, the Stoics, Grotius etc., but for the most part they include the existence of God, the knowledge of good and evil, right and wrong, the obligation to tell the truth, return debts, keep promises, some or all of the biblical Ten Commandments, and so on I do not know who first questioned this, but in modern times the main attack upon this was delivered by thinkers like Vico and Herder and Marx (and, indeed Hegel and his followers), and, of course, the empiricists, not Locke but Hume and his followers: according to whom, whatever the status of these Natural Laws, primitive men did not possess knowledge or even awareness of them, and they came into consciousness, or, indeed, formed objects of belief or certainty, in the course of evolution, or under the influence of changes in material circumstances and the growth of culture (whatever factions enter into that); for this entails that human beings go through a process of moral or metaphysical growth and development; and this is as valid is that empirical knowledge as an onward-going process, whether one believes that it tends to progressive development towards some kind of perfections or not – that it is cumulative, but possesses no identifiable structure or teleological tendency. This is certainly what Vico and Marx believed – that is, they believed that what is called human nature varies and differs from culture to culture or even within cultures – that various factors play a part in the modification of human responses to nature and each other; and that therefore the idea that all men at all times in all places are endowed with actual or potential knowledge of universal, timeless, unalterable truths (whether such truths exist or not) is simply false. For Marx, political economy undergirds economic arrangements. It is the result of the adaptability of people to new modes of production. Yet, during the time that a particular mode exists, it is considered to be the operation of a natural law. The principles guiding economic behavior in a particular production framework result from the socio-political structure of the time. No application of economic analysis to practical questions can be made without reference to such a structure or the prevailing philosophy of political life. At the core of philosophical Marxism is thus an understanding of social and political evolution through an historical conception of economic transitions, which, so to speak, gives voice to the change in human nature.

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The structure of society, politically and economically, can be explained by the existing mode of production. Marx argues that historical evolution is “directional” (without committing to whether this implies progress), and that it results from the conflict in changing social relationships that mirror the destruction and birth of different production and distribution arrangements. A mode of production is a way to identify the particular social form of economic relationships existing in a particular era. One can identify different economic relationships over the expanse of human history. These relate to particular modes of production and the socio-political structure supporting them. In ancient times we have the relationship of master to slave. In medieval times there was the relationship of lord to serf, and in modern times we have the relationship of owner to worker under capitalism. Marx sees societal evolution as the succession of such economic relationships, and he analyzes an economic-social system by delving beneath its visible expressions to ascertain its underlying realities. His goal is to expose the internal tensions (conflict) making for its transformation. Friedrich Engels makes this point when he tells us that “the ultimate causes of all social changes and political revolutions are to be sought, not in the minds of men, in their increasing insight into eternal truths and justice, but in changes in the mode of production and exchange; they are to be sought not in the philosophy but in the economics of the epoch concerned” (Burns 1935, p. 279). An economic (materialistic) interpretation of history can be set forth in two main propositions. First, the modes and conditions of production are the fundamental determinants of social structures. Social structures, in turn, create civilizations, thereby making economics the engine of history. Marx speaks in terms of the hand-mill breeding feudal and the steam-mill leading to capitalist civilizations. Second, social structures change over time; and they change in response to internal economic and social pressures arising from the workings of the production mode itself. Hand-mill production brings into being economic conditions in which a more mechanized mode of production becomes necessary. This machine-intensive mode created capitalism with its particular economic and social relations, and whose interactions work to transform capitalist society into another form. “Here, then, we have the propeller which is responsible first of all for all economic and, in consequence of this, for all other social change; a propeller the action of which does not itself require any impetus external to it” (Schumpeter 1950, p. 12). These two propositions contain a large amount of truth. But an economic interpretation of history is simply not a master key to all the secrets of human history. Social structures, once developed, remain in place for long periods of time. For Marx there are large interactions between the sphere of production and other spheres of existence. This stance gives Marx’s analysis great relevance, for he sees no discontinuities between the economic, the political, and the social forms of existence. But there is still the question of what drives this change. There is also the question of the philosophical rationale that led Marx to see his work as a

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Universal History of Mankind – not a catalogue of all that is known about mankind, but a means to find patterns in the overall development of societies. As to the first question, for Marx, all modes of production, as they have evolved from mankind in a state of primitive society, are not to be analyzed as a technical process that embodies inputs, or factors of production divorced from a social or economic class context. Marx conceives the production process as an environment of people in hierarchical economic class relationships maintained mainly by political power. In this framework, the social division of activity among classes of people, and its impact on production and its distribution, gets played out. Thus, the process of production within an historical period reflects the existence of an hierarchal standing and possession of power by a particular class of people that direct production, which is to say, organize the relationship between live labor power and the means of production. An important aspect of this power is the ability to maintain a particular distribution of the net product of society. Economists have been slow to look at social-economic class structure within the context of production. Most neoclassical economists reject the idea of people being stratified in a free society and reject the class approach to understanding the determinants of income distribution. Society is seen as composed of individuals who are presumed not to see themselves as the personification of economic categories, and hence do not embody class interests. In this context, individual behavior is determined by natural laws or general human laws that are independent of history (that is, independent of the stages of social development). Income distribution is presumed to be determined by such laws. It is “natural” that slaves, serfs, and wage laborers should receive a quantity of the social product enabling them to exist in their individual categories. Likewise, the master, feudal lord and capitalist each gets a portion of the net product of society as determined by their individual status in nature and the size of their reward depends on their position in the natural hierarchy. The master’s entitlement is the reward for his natural endowment of superiority; that of the feudal lord for his protective power and ownership of land, which he may lay claim to by natural right; and the capitalist is entitled to his position from ownership of the means of production, and his profit income is a reward for using this property in production. In each case, natural law holds that property rights are sacred and are to be upheld by legal sanction backed by government power. Another facet of natural law is the marginal productivity theory of distribution. It is a theory that purports to show how the conditions of production determine the rewards to factors of production in accord with the contribution each factor makes to the output of industry. According to this vision, the relationship between the capitalist and wage laborer is essentially harmonious – each makes a distinct contribution and each receives an appropriate reward. The different revenues of profits and wages are derived from different sources, and do not stand in a confrontational or hostile connection to one another. Much of Marxian economics can be read as an attack on this standard economic explanation. One might say that Marx “battered at it from the outside” by

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analyzing the different social relations in historical modes of production, while Sraffa, around 100 years later, showed that its inner theoretical structure was untenable, hence serving to “explode it from within” (Robinson 1980, p. 190). The individualistic approach of contemporary neoclassical economics reverses Marx. It tells us that the social relations in production, and the allocation of income flowing from it, are based on natural laws that become apparent through individual behavior. In contrast, for Marx, it is the consciousness of men in terms of their natural social and political life that determines the mode of production of material life. Marx explains the mode of production as reflecting particular social relations. These relations, being historically specific, cannot be explained by reference to trans-historic natural law. So, we cannot argue that capitalism will continue to exist indefinitely because it is human nature that some people become capitalists and others become wage-laborers. If one wants to treat people as individuals on the economic stage, then one needs to realize that they are the personification of the economic relations that exist between them. Economic entities confront each other as members of a larger group with similar traits. The problem with individualism is that it does not convey the consciousness that workers as a group possess within the stratified society where they exist. Society stratifies people; it thrusts them into class categories. At times these actions are subtle, at other times they are overt (e.g., facial features or color of one’s skin). For Marx, the essential principle, which is economic in nature and underlies all social relationships, is the connection that individuals have to the production process itself. Production congeals a group of individuals into an economic class and imparts social consciousness. This also becomes a platform for social change through collective class action. In earlier times this principle is illustrated by the slaves and slave owner (patrician) groups. The latter owned the “tools” of production, which included the slave. This gives us a class of people who entirely own the means of production, and another economic class of people who are the means of production. One can extend this mode of thinking to relationships between the feudal lord and serf as well as the landlord and peasant farmer. Marx divided modern capitalistic society into two economic classes – a capitalist class that owns the production processes of society, and a working class that owns their ability to work and are compelled to sell it. As long as the production of goods and services can be seen as a labor process, this distinction is indispensable. By virtue of the social position of these classes in production, the relations between them are necessarily antagonistic: The two fundamental classes are by virtue of the logic of their position and quite independent of any individual volition, essentially antagonistic to each other. Rifts within each class and collisions between subgroups occur and may even have historically decisive importance. But in the last analysis such rifts or collisions are incidental. The one antagonism that is not incidental but inherent in the basic design of capitalist society is founded upon

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This confrontation exists due to the presence of an economic surplus. It is extracted from production, and capitalists control the method by which the surplus is distributed between the economic classes. We have now found the answer to the first question posed earlier. It is the persistence of a class struggle that serves as the “propeller” of evolutionary change. Conflict between capitalists and workers is mainly about sharing the surplus, as labor strives to extract wages in excess of the social level of existence of the time. But it is also about the conditions of working on the factory floor, which need not always surface in the form of an armed struggle. Often class strife is waged in muted contests over legal entitlements or economic prerogatives. As Robert Heilbroner (1981, p. 71) reminds us, “It may indeed be almost completely disguised in the form of battles of ideas, or political or religious disputes, in which the immediate matters under debate conceal, even from the protagonists themselves, the underlying theme of class opposition.” This opposition may evolve into a changed relationship between the classes, say, with regard to the degree of exploitation within an existing mode of production; or it can culminate in a cataclysmic change in the socio-economic system. This brings us to the second of our two questions: whether class contradiction can explain societal change and give us a Universal History of Mankind. Marx was a student of Hegel and influenced by the Hegelian dialectic. He believed that the dialectic could be appropriated from Hegel and used as a method for his own vision of historical change. To understand the dialectic we must reach into Hegel’s Logic (1975) and The Phenomenology of Spirit (1977). The Logic is an analysis not of the methods of reasoning, but of the concepts used in reasoning. These were laid out by Kant as the categories of Being, Quality, Quantity, and Relation. The most pervasive concept is that of Relation. Every idea entering into a discourse of reasoning is a group of relation; one thinks about things only in relation to something else and becoming aware of its similarities and differences. An idea or an element of thought devoid of relation is an empty free-floating vessel that has no meaning and does not exist. For Hegel, the most universal relation is that of opposition or contrast: “Every condition of thought or of things – every idea and every situation in the world – leads irresistibly to its opposite, and then unites with it to form a higher or a more complex whole” (Durant 1926, p. 321). This is the concept of a dialectical movement, where opposing or contentious elements collide with each other. From such a collision there emerges a reconciling unity that evolves into a different or more complex stage of existence. This new stage may itself give rise to new and different contradictions, from which the human condition evolves into another form. Fichte was right in his formulation – thesis, antithesis, and synthesis constitute the secret of development and reality; as was Schelling when he speaks of

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an underlying “identity of opposites” (although Marx never used the Fichteian formula).1 Evolution is a continuous development of oppositions, their merging and reconciliation. “The dialectical process makes change the cardinal principal of life; no condition is permanent; in every stage of things there is a contradiction which only the strife of opposites can resolve” (Durant 1926, p. 321). We can appreciate why Marx would be attracted to such a philosophy of history, which appears to lead to the revolutionary conclusions that history is a continual process of conflict towards some final form of society. Capital was a rigorous intellectual and scientific work. It sought to explain how capitalism came into being from this Hegelian process, to determine the economic laws of its operation, and to lay out the basis for its eventual decay. Marx considered his work to be more than a scientific description of the capitalist economic structure. He was engaged in an emotional battle for a cause – the end of poverty and oppression. Capital was a tool to arm workers by awakening them; that is, to have them understand their economic oppression, and persuade them to change the social and economic order. Such change must involve the political order as well, since political power and economic power are closely intertwined. So we have provided some insight to our second question concerning the philosophical underpinning for Marx’s approach to a universal history. Although Marx was grounded in the Hegelian view that the historical process is dialectical, Marx and Hegel differed over what kind of society would emerge at the end of history. Each conceived of a different final form of society that was free of contradictions. For Hegel the dialectic was a process for the evolving nature of thought; that is, of the self-consciousness of man (Gadamer 1976). “The movement of thought, then, is the same as the movement in things; in each there is a dialectical progression from unity through diversity to diversity-in-unity. Thought and being follow the same law; the logic and metaphysics are the same” (Durant 1926, p. 322). Consciousness refers to the perceptions of the mind, the way people think about basic questions of right and wrong, the way they perceive the world. It is the very nature of man, our state of mind. Hegel believed that all human consciousness is formed in the context of, and is limited by, the cultural conditions of the time. One key element in establishing this environment is politics. The function of politics it is to mold or unite individuals into a state. Thus, the dialectical movement must be understood as a succession of different forms of consciousness or forms of human nature, and not merely as a succession of different economic modes and material accomplishment. Human nature, the way in which one perceives and answers the basic questions of existence, is molded by real states and institutions. “Hegel’s Universal History gives an account not only of the progress of knowledge and institutions, but of the changing nature of man himself. For it is human nature to have no fixed nature, not to be but to become something other than it once was” (Fukuyama 1992, p. 62). Hegelian dialectics sees human nature evolving to an Absolute where all contradictions are resolved, where mind and matter, subject and object, good and bad, are one. It is a state of being reflecting the highest level of rationality

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and freedom. This Absolute transcends individual limitations and purposes; it is the underlying explanatory force for determining history. The path to achieving the Absolute lies in freedom, which is “the open avenue to change” (Durant 1926, p. 324). History is the growth of freedom, and the state is the mechanism for organizing freedom. For Hegel, the embodiment of human freedom was the modern constitutional state, or liberal democracy. “The Universal History of Mankind was . . . man’s progressive rise to full rationality, and to a selfconscious awareness of how that rationality expresses itself in liberal selfgovernment” (Fukuyama 1992, p. 60). Liberal societies were free of the contradictions that characterized earlier forms of political and social organization that led to their passing. The Hegelian end of history comes with the achievement of a liberal state with universal freedom. Thus, Hegel was the philosopher of freedom. He saw the historical process culminating in the realization of freedom in concrete political and social institutions. For Hegel, this implies the existence of private economic and political activities independent of the control of the state. But this independence does not contain contradictions, as the political structure “guarantees” the order within which mankind can reach the Absolute. According to Marx, this emphasis on order, or on politics providing freedom through the presence of the state, has placed Hegel in a contradiction. Holding that history is the growth of freedom, Hegel could be accused of worshipping the authority of the state, and being an enemy of liberalism. This is a narrow view, if not a misunderstanding, of the Hegelian notion of “order;” but it informed Marx’s take on Hegel. Marx took Hegel’s praise of the state as supporting the capitalist economic class within the state. In Marx’s view, the Absolute would not result in universal freedom where all men realize the freedom of self-consciousness, but would result in freedom only for the ruling economic class. It bears repeating that we are talking about the freedom of the mind; that is, where one is not subject to a thought process that restricts the vision of one’s place within society with the subsequent loss of one’s destiny. In the Absolute, the mind has freed itself from exiting modes of self-consciousness; it is no longer in a state of being alienated from itself. Hegelian freedom is a philosophical freedom or a state of mind. But this freedom will not exist for all men as long as Hegel’s final form of society contains opposites or contradictions; and for Marx it certainly does, since it does not resolve the one final contradiction – that of class conflict. Workers cannot experience freedom because worker consciousness is shackled by alienation. The worker cannot see himself in the creations of his labor. He is controlled by (or a prisoner of) the very means of production (which are themselves products of past labor) he brings to life by applying his own labor. This alienation of labor, which has its roots in human practice, can be summed up by saying that it is not the workman that employs the instruments of labor, but the instruments of labor that employ the workman. Capital, a human creation owned by the capitalist class, controls workers; indeed, Marx makes the observation that the object of the machine is to transform the laborer into a part of a detailed machine-dominated production process.

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This alienation of labor prevents workers from attaining Hegel’s freedom of the mind and a life in the condition of the Absolute. Thus, the Hegelian final form of society, the one existing at the end of history, is not that at all; it is a piece of unfinished business. The final end will come when the final contradiction ends and mankind is freed from the alienation of labor and the domination of one class by another. Thus for Marx the end of history will come in the form of a society with only one class of people. This means the end of “opposites” and the achievement of freedom of the mind, as well as the freedom to connect intellectual power to the power of manual labor. Both Hegel and Marx shared the vision of an end to the dialectic movement, or an end to history; but they differed over how they saw the final form of society. Where Hegel offered the mental process of the Absolute as determining history, Marx offered the practicality of mass movements and economic forces.

The message Capital was written to provide the intellectual tools to foster the class struggle. It sought to arm the working class and to precipitate the antithesis that would eliminate that last contradiction. Marx needed to demonstrate to the working class the nature of their exploitation, and to awaken them to the fact that they were exploited. People who spend their lives in a state of alienation from themselves, with no control over their destiny, may come to feel that such is the natural order of things. Marx’s message to the working class is that economic life, and the condition of people’s lives, arises out of the socio-economic class relations inherent in capitalism. Consequently, there is nothing natural about it. Marx brings class relations to the surface and makes its impact clear through the concept of “value.” He does this by relating unobserved value magnitudes in commodities, stemming from the expenditure of necessary labor time, to the observed magnitudes of exchange values. We observe the prices of exchange and profit levels. Commodities express, via their prices, how much they are worth; money serves as the unit of account in setting the value of an article in its price form. Price is the expression in money, or the money name of the magnitude of labor value realized in a commodity. This value is validated by the commodity’s exchange price. Through the value concept, Marx was able to demonstrate how the exploitation of labor (by which we mean the ability to compel the performance of surplus labor) can be reconciled with the freedom of the worker to choose his employer and type of work. For Marx, this is an imagined economic freedom; the freedom to choose one’s work or employer will not free one from the conditions of exploitation. A worker’s existence is tied to his employment; and this employment is controlled by capitalist’s monopoly over the means of production, by its ownership of the output produced by workers, and by its control over the conditions and work time of employment. Work, therefore, may be referred to as “wage-slavery.” In considering the working conditions in the mid-to-late nineteenth century, when Marx was writing, we need to keep in mind that the

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social and economic environment had not evolved to the point of allowing labor to organize and form a strong countervailing force to challenge the capitalist class monopoly. Even in the early twenty-first century, with this force generally in place (although weakened considerably), we find employment conditions that Marx would certainly recognize. In many places around the world, feudal arrangements, if not outright bondage, exist. Marx makes it clear that value constructions (via the embodiment of labor power) explain the distribution of income and the exchange prices of commodities. The capitalist translates his search for profit maximization into operational strategies within the production arena. However, the domain for the pursuit of profits does not lie in circulation, although the profit strategy can only be realized in circulation. The exchange mechanism does not “produce” the profit; to think this way we divorce profits from production and see profits as simply a monetary magnitude added to the value of direct labor (and replacement means of production) through the power of the capitalist to enforce an unequal exchange. This explanation blinds us to the role of labor in creating profits within the arena of production, where the capitalist works on the laborer to produce surplus value in the form of a quantity of goods that exchange into money profits. This is a basic Marxian principle – exchange outcomes should be analyzed in terms of the conditions of production, which are brought to light via value constructions. For Marx, awakening labor to their exploitation was the primary job of the theory of value. His analysis has prices and profits mirror the labor power embodied in the commodity. This enables him to connect value concepts to recognizable economic outcomes, and to show that workers produce profit income. His message is that the rules of the capitalist game are stacked against the working class; not only do they have no say concerning the conditions of their employment, they also have no entitlement to any portion of profit income that is created by their labor. To demonstrate this, the first step is to construct an ongoing economic system that reproduces itself at a constant level of production. Our concern is not with the growth of output from period to period, but with an existing level of output (and its distribution), that results in the system maintaining itself. These reproduction models (simple and extended) were introduced by Marx in part VII of Capital to shed light on the integration of production in capitalism. Production is based on an interdependence of sectors; and specific conditions have to exist if the output of each sector is to meet the input requirements for its output from all the other sectors. In this context there is no accumulation of capital; the entire output of the system is used only as inputs to reproduce the same level of output. All profits (i.e., all surplus value) get used to replace used-up means of production, and for consumption. Extended reproduction occurs when capitalists save a proportion of their income and invest it to increase their capital, thereby generating production growth in their own sectors. Our concern is with the simple reproduction model and its underlying assumptions, which is sufficient to support Marx’s message and his call for eco-

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Table 3.1 The production conditions Sector III Iron III Corn III Gold Total

Means of production

Direct labor

80 t. iron 10 t. iron 30 t. iron

40 hours 50 hours 30 hours

120 t. iron

120 hours

Output 120 iron 60 corn 60 gold 240

nomic change. Our economy will consist of three sectors, each with its particular production process. This physical scheme is seen in Table 3.1. Each sector requires a portion of the iron sector’s production, including the iron sector itself, which uses 67 percent of its own production. The output of 120 units of iron (at the end of a production period) enables each sector in the subsequent period to obtain the required means of production so that (with the technically determined direct labor requirements) it can reproduce at the existing production level. Iron output is the basic ingredient of the economy in that it is a produced commodity that is directly necessary to all the production processes. The availability of this basic commodity limits aggregate production. Each sector must renew its entire means of production in each production period. Given the reproducibility characteristic (and no technical change), each sector’s requirements remain unchanged and all the sectors absorb the whole of the iron sector’s production. There is, then, no net output of iron, or no accumulation of capital, to allow for greater levels of production. This ongoing reproduction implies that each sector realizes an exchange price for its output that enables it to purchase the production requirements of the means of production and associated labor power, and to earn a rate of profit reflecting its particular production process and extracted surplus value. There is no tendency for the equalization of profit rates between different lines of production. There is sufficient demand to absorb the net output of the system with existing prices and incomes; thus, for each sector, the output is sold because it is produced and it is produced because it is sold. In Marxist terminology, there is no realization problem; each capitalist sector realizes (through its price within the arena of circulation) all the value created within its arena of production. Coordinating the production of the different sectors involves relations of circulation as well as production. While there is no net output for the iron sector (the basic sector), there is a net production for the economy as a whole, equal to the difference between total production (240) and the portion of it going to replace the aggregate used-up means of production (120), which equals production of the iron sector. Thus, the net product is equal to the combined output of the corn and gold (capitalist luxury consumption) sectors, which is totally absorbed by wage and profit incomes. The next step in this example is to “mine” the production conditions for their Marxian values. We designate the labor value per unit of output for each of the

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sectors as i, c and g. Turning to the iron sector, we note again that the production of 120 units of iron requires 40 hours of direct (live) labor involvement, plus 80 units of previously produced iron as means of production. But it is not this physical iron that is important here; the 80 units represent, and bring to the production process, the embodied (dead) labor value in its own production. Thus, the 80 units impart to the production of 120 units of iron all of the labor involved in its production, since all of the 80 units are consumed in the production of 120 of iron. The labor value of the iron sector is then equal to 120 units multiplied by the labor value per unit, where this total comprises of 40 of direct labor value plus 80 units of iron multiplied by its labor value per unit. The iron production process in value terms is: 80 i  40  120 i i  1 Knowing the labor value per unit of iron we can solve for the value per unit of corn production and the value per unit of gold production, which are c  1, and g  1 respectively. There remains an additional “commodity” integral to these production processes and that is not accounted for – the labor value per unit of the direct labor itself. This is what is required to reproduce the labor power expended by a unit of direct labor; it is the value in the necessary consumer goods basket. We assume that the basket consists of 60 units of corn for the direct aggregate quantity of 120 units of labor. Knowing the labor value per unit of corn, we have a total labor value of 60 or a value of 0.5 per unit of labor. When we look at the net output we find that the direct labor produces an output of 120 in value terms, of which 60 represents the necessary value for labor to reproduce itself, and the additional 60 being total profits that is taken up by the gold producing sectors. The output of the system is the physical form of expended labor power; it results from employing a quantity of direct labor in conjunction with past labor. In the arena of circulation this physical form acquires a money magnitude. It is taken up as expenditures to reproduce the worker’s labor power (the wage bill), as expenditures to replace the means of production, and as “expenditures” in the form of profits claimed by the capitalist. The important issue concerns what we observe and what we do not observe. We see the monetary transactions involving produced commodities; we do not see what is really being exchanged – the labor values embodied in the commodities themselves. Commodities are the form taken by this labor value; its price is the sum of labor value embodied in it. Determination of these values was based on initially specifying the conditions of production; as we said, the value magnitude is a quantity put into commodities by the amount of labor required to produce them. The term “put into” requires some clarification. What determines the physical production data of the system? Is it not the labor process itself? It is human labor activity that transforms the inputs of labor,

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both direct and past, into output; only when such laboring is successful do we have production data. If the labor process produces commodities, it is a process in which labor value materializes in the commodities themselves. Thus, the outputs of the system are the use-forms of the materialized labor values; the inputs (produced outputs) possess the same characteristics. So, if we use the physical data or the conditions of production to calculate values, we are calculating something that already exists in production. It is not a matter of the conditions of production determining labor magnitudes, although this is what it appears to be when we look at the calculation of labor values. To say that value is “put into” a commodity by production conditions means that production conditions reveal values already there. Physical data summarize the real value determination of the production data. As Anwar Shaikh (2005) notes, the idea of determining values from the production data, “no more determines these values than does the calculation of the mass of the earth determine the earth or its mass. It merely recognizes what already exists.” Returning now to the main argument, when dealing with exchange values we transform the simple reproduction physical schema into a direct-price relationship drawn from our labor value calculations. We see this in Table 3.2, where we find a rate of exploitation (the ratio of surplus to necessary labor value) equal to unity. Considering variable capital (v), which is the wage bill, we observe that as the labor value inherent in the consumption basket to sustain a unit of direct labor is 0.5, then, in the iron sector for example, the 40 units of direct labor receive wages of 20 which is the money equivalent of the labor value to sustain that sector’s direct labor. Similar calculations yield the wage bill for the other sectors. The rate of profit is calculated as the ratio of surplus value to the aggregate capital outlay (both direct and past), where this capital is reckoned in labor value terms; it is measured in terms of the labor necessary to produce it. Let us consider how this direct-price relationship might resonate with workers. What is immediately evident is that the most visible outcomes – commodity prices are determined by and equal to the quantity of labor value embodied in their production. There is no obscuring the message that the outcome of exchange is based upon the relations in production. Furthermore, profits emerge as a residual of value-determined prices, given the wage bill and the composition of capital. It is then straightforward to equate profits with the level of Table 3.2 The direct price relationship Profit Sector III Iron III Corn III Gold Total

c

v

s

Value

s/v

c/v

Rate (%)

Prices

Profits

80 10 30

20 25 15

20 25 15

120 60 60

1 1 1

4 0.4 2

20 71 33

120 60 60

20 25 15

120

60

60

240

240

60

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surplus value extracted in production. Marx would have us always keep in mind that profit is a labor-creating element through the expenditure of surplus labor power; where such expenditure is not visible it is given visibility in the arena of circulation by the realization of profits. The aggregate surplus value is distributed in accord with the amount of labor each sector employs. Each sector receives a percentage of aggregate profits equal to the percentage of aggregate surplus value that it generates. Marx’s goal was to employ value concepts to illuminate the economic relations of capitalist production, and to build a pricing and distribution model that illuminates these relations. This meant presenting profits (the non-wage share) as a surplus product created by labor power, or showing that profit is unpaid labor. The result presents a clear justification for workers to claim the entire output of their labor power, and to forge a distribution system that is not class structured or exploitive. Marx wanted the working class to bring about a reality different from the economic relations of capitalist society. Marx knew that he was not proposing a mechanism to explain prices or the rate of profit in the economy that he saw about him. In this framework, existing prices would not be direct prices reflecting the classical law of value. They are not proportional to the quantities of embodied labor values. Marx understood the nature of prices of production; but he constructed his initial analysis on the direct-price assumptions because it let him clearly explain the concept of value, bring out the social relations in production, and demonstrate that labor power is the basis for observable monetary outcomes. There is good reason why Marx, in volumes I and II of Capital, assumes that prices are direct prices. When the economy is in a simple reproduction state or a self-replacing state, profits will always be seen as a surplus product. Indeed, Marx based his production co-ordination models on assumptions brought out by our direct-price example – all commodities sell at their values (there is no issue of the transformation of values into prices of production), and there is no capital mobility between sectors and thus no tendency for the equalization of profit rates. The direct-price example has legitimacy in its own right. It should not be seen as a way station towards the transformation procedure of determining prices of production from direct prices, or as going from Marx’s value system to his pricing system. In subsequent analyses Marx abandons the assumption that commodities sell at their values. This was done partly because of an interest in the determination of prices, but also because he wanted to show that the value constructs, and the message emerging from the direct-price relationship, still hold in the context of competitive capitalism and related prices of production. Despite the divergence of these competitive prices from their values, Marx still held that prices and profits are ultimately derived from values. The direct-price relationships in Table 3.2 support Marx’s fundamental purpose, which was an analysis supporting his call to change the economic system. This analysis revolves around the theory of value, which illuminated the inner workings of capitalist production; it was not a means to ascertain prices.

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But to admit, as Marx would, that there is not an equivalence between prices and embodied labor values is not to say that there is no connection. Marx emphasized the rate of exploitation rather than the behavior of the profit rate on prices because what is important is the amount of surplus product extracted by the exploitation of labor; so the focus had to be placed on the ratio of surplus value to necessary value, rather than on the ratio of surplus to employed capital. The former concerns the origin of profits, while the latter is an institutional characteristic. Robinson (1980, p. 186) imagined Marx speaking the following words as he reflected on the direct-price construction: I am interested in the mode of production, and the distribution of income. I have a theory of the share of profits – the rate of exploitation. The share of profits is far more important than the rate of profit. The share of profit is something that actually happens and affects people’s lives – the rate of profit is a mental calculation. Perhaps Marx should have remained on a high philosophical level, analyzing the tides of change in human history and the stratification of society through his materialistic interpretation of history, rather than venturing onto the terrain of price theory. On the level of price theory, his work ran into some understandable difficulties, which led to a vast amount of criticism. Over time, these criticisms have become a mainstay in discussions about Marx (aside from those who dismiss Marx outright because of a presumed relationship to Stalinism) and have caused us to miss the essence of his thinking.

Marx now Marxian economics provides an alternative to orthodox (neoclassical) economic reasoning and forces us to question the neoclassical paradigm. Yet Marxian economics is more than a technical assault on the neoclassical school of thought; it is an instrument for radical change in the socio-political framework of society. All economic doctrines come to us as propaganda because propaganda is bound up with the very nature of economics. As Robinson (1955) tells us, “to pretend that it is not so in the name of pure science is a very unscientific refusal to accept the facts.” Economics is concerned with the actions undertaken by the capital and labor components of a production process, and with the consequences of these actions on the entire economic system. Economic paradigms are then about structures or rules that determine behavior. These structures reflect the economic propaganda of the time, and are set up to run the economic game. Along these lines, the neoclassical marginalist paradigm should be taken as a propaganda vehicle (or a piece of unscientific apologetics) to further the interests of the capitalist class. Robinson (1962: 52) goes so far as to claim that “the whole point of utility theory was to justify laissez-faire.” The marginal productivity theory of distribution as promulgated, for example, by J.B. Clark (1965

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[1899], p. 7) was a means to attack Marxian exploitation theory (see also Henry 1983). It allowed neoclassical economists to argue that the relationship between the capitalist and the worker is harmonious because each earns his particular contribution to production. The capital-profit and labor-wage income flows are merely derived from different sources. They do not stand in any hostile relation to one another, and they are not antagonistic to each other because they appear not to have any inner connection. This view, which Marx considered vulgar economics, is the result of marginalism failing to peer underneath the rewards determined by markets. This neoclassical approach, considered as natural law, also undermines the call for intervention in the workplace or in the income flows stemming from it. This brings us to the divide in economic thinking that took form after Ricardo. The classical tradition, in whose footsteps Marx followed, maintained that to understand observed market phenomena, one had to penetrate beneath it and find the underlying production relations. “The classical labor theory of value was . . . an analytical embodiment of this methodological principle; and the classical theories of distribution which laid much stress on the class relationships between the recipients of factor incomes, were also closely bound up with it” (Meek 1977, p. 166). There soon followed a paradigmatic shift away from this methodology. The shift was marked by the emergence of a subjective theory of value anchored in the notion of innate utility calculations resulting from the psychological relation between man and finished goods; and, as we pointed out, by the desire to get away from class categories in production. One way to perceive the difference between the classical-Marxian approach and the marginal approach is in terms of how each views scarcity. For classical economists, scarcity was a simple prerequisite of a commodity whose price was determined on the basis of the physical costs of production; it is based on the means of production, including labor, necessary to obtain a given quantity of output. Price and income distribution also are based on technical relationships within the production process. This places the emphasis on reproducibility (as in Marx’s simple reproduction model) and the requisite income distribution necessary to sustain it. For marginalists, in contrast, price is an index of scarcity, and scarcity is viewed in a quantitative rather than a qualitative sense. It is obtained by comparing the quantity supplied and quantity demanded at different prices. Neoclassical economists also apply market-determined outcomes (reflecting relative scarcity) to labor and capital; income distribution has nothing to do with economic classes and the relationship between them (see Walsh and Gram 1980). Marginalism has come under attack during the last 50 years or so. These attacks initially appeared desultory, but soon took on coherence in the Post Keynesian paradigm. An early salvo was fired by Piero Sraffa in his 1926 article on the laws of return (Sraffa 1926). Robinson’s article (1953) on the production function and capital and her book Accumulation of Capital (1956) fueled the attacks. In the ensuing years, many central principles of orthodoxy were found to lack a sound theoretical basis, and so could not help us understand the work-

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ings of a modern capitalist system. There are problems with the utility and the formation of the demand curve; the marginal productivity theory of income rewards; the approach to explain prices (including a profit rate) using a cost function and a demand function (see Keen 2001). Also egregious was the implicit acceptance of Say’s Law, the view that there exists an automatic mechanism producing the necessary level of effective demand and full employment that allow reproduction. In these matters the critique of marginalism can be traced to Marxian economic theory – aided by such giants of heterodoxy as Sraffa, Robinson, and Pierangelo Garegnani (to name only a few) that have refined and expanded Marx’s work. While Marx did not put forward a formal theory of effective demand, it is implicit in his reproduction models. His extended reproduction scheme became part of the Post Keynesian paradigm, due to the work of Michal Kalecki, and was given operational form to serve as the basis for theories of economic growth (see Setterfield 2001). All this offers us an opportunity to infuse Marxian ideas into our understanding and teaching of economics, and to do so openly. The Post Keynesian paradigm, in its confrontation with marginalism, brings with it a fuller appreciation of Marxian economics as a way to understand capitalism. It gives us a way to redeem Marx from the mess that Stalinism made of him. There is another path that brings Marxism to modern issues. This comes from the experience of working people in many parts of the world due to globalization. We live a world where international finance, underpinned by military and political power, has become strongly interwoven with industry and trade. It may be said that in many respects, globalization is the modern face of the older concept of imperialism. Imperialism describes a particular stage in the development of capitalism. Lenin (1933) refers to imperialism as the highest stage of capitalism, its monopoly stage. For Lenin, the essential features of this stage are: 1

2

3

A concentration of production and capital that turns competitive capitalism into monopoly or oligopoly capital. Thus, several advanced monopoly capitalist economies stand on a competitive footing with respect to the world market for commodities. The merger of bank capital with industrial capital, forming the basis of finance capital. Finance capital then seeks to penetrate foreign markets. Indeed, the export of capital becomes more important than the export of commodities. The formation of international capitalist monopolies, leading to a territorial division of the world among the major capitalists.

To understand this we need to transfer our thinking away from a closed system and towards an open system. In a closed system, capitalists are driven by the desire for ever greater profits, and invest their surplus in more and more capital as they strive to raise the productivity of their workers (i.e., increase the

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rate of exploitation), thereby increasing the total product. In an open economy, capitalists, driven to augment profits, invest their surplus in foreign states to take advantage of their low-cost and semi-skilled workforce. The result is a heightened rate of exploitation, with real wage remaining at low levels. The modern context of globalization does not imply the penetration of weaker agrarian societies by stronger industrial states for the purpose of extracting raw materials; rather, globalization is an attempt to reduce production costs and maintain profit levels. In the little that Marx wrote about the colonization of weaker societies (the globalization of Marx’s time), he pointed out that such actions could increase the reserve army of the unemployed in capitalist economies and that the export of capital can help counteract the falling rate of profit. However, his analysis of the falling rate of profit is open to question even within the context of a closed economy. What is not open to doubt, and is a main point in understanding modern-day globalization, is that workers in these semi-colonized states cannot present a countervailing force to the monopoly capital of the developed country. They must accede to the work rules set for them under threat of being thrown out of work or worse. What we find in the world is the coexistence of several types of socio-economic systems that globalization has brought into sharper focus, and which Marx can help us understand. There exists in the world today outright slavery and remnants of feudalism, which is tragic, to say the least; but we also find overlapping stages of economic development, with many nations attempting a mixture of socialism and capitalism. Benign welfare capitalism co-exists with a rapacious capitalism that maintains the horrific working conditions and confrontational class relationships that Marx observed. At the outset of the twenty-first century, the rapacious form of capitalism has reappeared in many parts of the world. Consider the following description of working conditions in El Salvador (Becker 2004): Marina del Carmen Levia, a 32 year old mother, struggles to keep her job earning $152.00 every month bent over sewing machines, making clothes for famous American brand-name companies. The pressure to produce garments is so great, she says, that she and her co-workers are regularly refused permission to visit the bathroom or to get a drink of water for fear it would slow the line. If they would just treat us like human beings, even without raising the minimum wage, my life would be better, says Mrs. del Carmen Levia. This evokes images of prisoners returning to confinement after an allotted outing. Admittedly, this may be a too harsh interpretation. Nevertheless, the ombudsman for human rights and working conditions in El Salvador notes: “This is quite a hostile environment for workers, where the business and government sectors see protecting workers’ rights as going against the country’s economic interests. CAFTA protects the fundamental rights of businesses but not the labor rights of its citizens” (Becker 2004). CAFTA stands for the Central American Free Trade Agreement, which promises more trade with the United

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States, and includes Costa Rica, Guatemala, Honduras, Panama, and El Salvador. It calls for these countries to do a better job of enforcing their national labor laws; however, this enforcement is questionable in the absence of guarantees and when there exists hostility to labor’s right to organize. The poor record that El Salvador has upholding its own laws (and this applies to a greater or lesser degree to the other countries in CAFTA, as well) is the result of an unspoken national policy to overlook enforcement in the drive to heighten the rate of exploitation and increase surplus value. The aim is to provide a better profit environment for foreign capitalists to locate their factories where they are not required to pay most taxes and are unencumbered by state interference in their operations. Were Marx alive today, he would recognize these factories as hot-houses where the productivity of labors is made “to ripen.” The clothing factories in El Salvador present the image of workers swallowed up by a gigantic machine for the entire working day, during which time the worker is turned into a cog in the production process. When the workday is over, the worker is spewed-out to partake of the necessary subsistence that replenishes his or her labor power and lets the process start over. This image is generally valid for semi-colonized countries; and it is through Marx that one can illuminate and understand what is going on in the production underbelly of global capitalism. Armed with Marx as a central part of our economic discourse, we should be able to dispute the often-heard viewpoint that such conditions of existence are part of the natural order of things. We can see that this attempt to evoke natural law is a way to close one’s eyes to what is happening below the surface and to forestall actions to improve working conditions throughout the world. Armed with Marx we can also recognize the negative side this new world of globalization – a world in which the integration of financial networks, information, and trade is binding the globe together and shifting power from governments to markets. The results of the ascendancy of markets is that economic relationships such as the pattern of wages and prices, and the conditions of production and the distribution of income shares, are seen as the result of market forces, conceived of as laws largely independent of human will and akin to the mathematical laws of the physical sciences. The relevance of Marx to the economic world today is that it leads us to reject the orthodoxy of the past 100 years. This orthodoxy has abstracted from the central capitalist reality of the socio-economic relations in production. It has also kept us from considering important economic issues such as technological change and its relationship to employment, income distribution, and economic growth. A study of Marx focuses our attention on the power relationships between economic classes and the role of institutions in determining economic outcomes. We cannot see the reality of the workings of capitalist society as long as we remain blinded by the glare of orthodox market models and the pervasive sense of “natural” economic outcomes. Appreciating the necessity of including Marx in economics leads to the question of what Marxism is in our time. There would seem to be two approaches

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here. One is a continued commitment to establishing a socialist mode of production as a first step towards a communist society. This socialism would go beyond the socialist or social democratic societies of today, and well beyond the welfare capitalism found in the United States and other developed countries. Regarding such fundamentals as conditions of work, the social order, and the basis for the distribution of the national income, socialism is a “new formation and not merely an improvement of relations that are essentially capitalistic in nature” (Heilbroner 1981, p. 158). It would eliminate what Marx refers to as “worker alienation” by returning to a system of production in which an individual worker can apply his skills to the production process and have a “stake” in the end product, similar to what one might find in the labor of the self-employed craftsman. Workers would make use of the machines, rather than machines making use of the worker as in the impersonal giant factory. Modern society has resulted in people becoming alienated from the end result of their work. Heilbroner’s (1981, p. 72) words are to the point: “The working person becomes separated from the product of his own labor. His work, once the very expression and incorporation of his generic being, now confronts him as a thing apart, indeed as a thing that commands him as property.” But there is a very important difference between the economic classes. Marx tells us: “The possessing class and the proletarian class represent one and the same human self-alienation. But the former feels satisfied and affirmed in this self-alienation, experienced the alienation as a sign of its own power, and possesses in it the appearance of a human existence. The latter, however, feels destroyed in this alienation, seeing in it its own impotence and the reality of an inhuman experience” (Tucker 1978, p. 133). To lift this psychological burden requires changes in the design of production, changes that can have the unintended consequence of reducing labor productivity. Marxists have not put forth a program detailing how one brings about the humanization of work, restoring “the stolen powers of self-expression and fulfillment that lie in work” (Heilbroner 1981, p. 150). In Marx’s colorful language, “It would that our products be so many mirrors from which our being shines out to us” (Fetscher 1971, pp. 36–7). One form of alienation can be dispensed with by the break-up of the economic class structure. By so doing, we end the alienation of man from himself that results from one man selling himself (his labor power) to another. To bring this new socio-economic order into being will require that the people acquiesce in some degree to a strong central political authority. Present-day Marxists must explain how economic rights can be preserved (especially the right to withhold one’s labor) under the condition of the new order. But from a broader perspective, the question is whether this socialism can be compatible with political democracy, and with social, intellectual, and religious diversity. The balance that needs to be struck is between individual liberty and the curtailment of freedom necessary for the social unity that will change the economic order. Contemporary Marxists must speak to these issues. Recent history has shown that if a socialist way station is characterized by despotic political power, it will

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breed tensions and may lead to an upheaval that restores the old order. Yet it is unlikely that the individual will be remade by the state; so this new order will have to discover the proper relationship between the individual and society. Marxists should adopt the principle that while the economic arena is greatly centralized, there could exist alongside it an independent political arena that is wedded to the central economic program. What should a Marxist be committed to as a practical matter, in order to safeguard Marxism from being relegated to the dustbin of outmoded and fossilized ideas? Marxists need to jettison the holy Marxist grail of a communist society as the culmination of history. Unless the nature of man is to be totally remade, the end state is likely to be some form of social democratic economy found in many advanced capitalist societies. It is not a matter of going beyond the capitalist welfare state, but of accepting its tenets of political diversity and personal freedoms, and the commitment of the political authority to “bridle” the excesses of private market behavior. It aims not to do away with class relationships and a remake society, but to reduce the exploitive power that one class wields over another and to press for a greater equality in sharing the national output. The tendencies in this direction will wax and wane over time. Marxists need to apply Marx as a tool to understand the operations of such a hybrid socialist system and to continually prod it in the direction of achieving the greater social good. This approach does not abandon Marx; for as long as capitalism exists, Marxisan analysis will be necessary to reveal its inner nature. If capitalism does not fade, but continues in one form or another, understanding it will require Marxian economics. Marx’s message of revolutionary change in society’s socio-economic structure, which we looked at earlier in this essay, was right for his time. He was correct in his understanding of dialectics as the underlying force propelling historical change, and for encouraging the working class to overthrow capitalism as a means to deliver the inevitable and final synthesis. Yet Marx could not have foreseen how successful, in a sense, his message turned out. He was not successful in spurring a world-wide proletarian revolution, but he did succeed in fostering the combativeness of labor. We have seen capitalism altered from its rapacious form in Marx’s time to modern forms of welfare capitalism, where the political and economic spheres are intertwined, and where workers have escaped from a state of immiseration (as Marx characterized it). Marx would not be chagrined that labor has been able to acquire a share of the higher technical productivity fostered by capitalism. In this form of capitalism we see the working class developing capitalist values and acquiring an anti-revolutionary state of mind. But this happy condition may have begun to wane. There is evidence that labor’s ability to countervail capital is eroding. We find a growing hostility to organized labor and growing pressure to increase productivity by changing working conditions rather than by technological improvements and advances. We would also note that one feature of the economic expansion in the early twenty-first century is the unusually low share of national income earned by labor. In fact, the share of income

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received by labor in has fallen to a post-World War II low in many developed countries. Moreover, in many countries capitalism is practiced in an avaricious manner more akin to Marx’s time, than to what we have become accustomed to in our own time. This suggests that if Marxists are to have an impact on capitalism today, they should forsake the romance of a call to revolution, and take up the burden of protecting and advancing labor’s rights. Where inhumane working conditions exist, they need to be labeled as such and we need to engage in a battle for public opinion to change matters. Can this be done under the banner of Marxism? I believe it can. The ongoing goal is to temper market outcomes with human values, and to promote the understanding that worker rights are human rights.

Note 1 Fichte, Schelling, and of course Hegel were the major followers of Kant who dominated the philosophical thought of the nineteenth century.

References Becker, E. (2004) Amid a Trade Deal, A Debate Over Labor. New York Times, June 4, p. C1. Berlin, I. (2004) A Letter on Human Nature, The New York Review of Books, 51 (14), p. 26. Burns, E. (ed.) (1935) Handbook of Marxism. New York: Random House. Clark, J.B. (1965) [1899] The Distribution of Wealth. New York: Augustus Kelley. Durant, W. (1926) The Story of Philosophy. New York: Simon and Schuster. Fetscher, I. (1971) Marx and Marxism. New York: Herder & Herder. Fukuyama, F. (1992) The End of History and the Last Man. New York: Free Press. Gadamer, H.-G. (1976) Hegel’s Dialectic. New Haven, CT: Yale University Press. Hegel, G.W.F. (1975) Logic: Being Part One of the Encyclopedia of the Philosophical Sciences. Oxford: Oxford University Press. Hegel, G.W.F. (1977) Phenomenology of Spirit. Oxford: Oxford University Press. Heilbroner, R. (1981) Marxism: For and Against. New York: W.W. Norton. Henry, J. (1983) John Bates Clark and the Marginal Product: An Historical Inquiry into the Origins of Value-Free Economic Theory, History of Political Economy, 15 (3), pp. 375–89. Keen, S. (2001) Debunking Economics: The Naked Emperor of the Social Sciences. London: Zed Books. Lenin, V.I. (1933) Imperialism: The Highest Stage of Capitalism. New York: International Publishers. Marx, K. (1957–62) Capital, 3 vols. Moscow: Foreign Languages Publishing House. Marx, K. (1971) [1859] Critique of Political Economy. London: Lawrence & Wishart. Meek, R. (1977) Smith, Marx & After: Ten Essays in the Development of Economic Theory. London: Chapman & Hall. Robinson, J. (1953) The Production Function and the Theory of Capital, Review of Economic Studies, 21, pp. 81–106.

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Robinson, J. (1955) Marx, Marshall and Keynes. Delhi: Delhi School of Economics, University of Delhi, Occasional Paper #9. Robinson, J. (1962) Economic Philosophy. London: Watt. Robinson, J. (1980) What are the Questions? Armonk, NY: M.E. Sharpe. Schumpeter, J. (1950) Capitalism, Socialism and Democracy. New York: Harper. Setterfield, M. (2001) Macrodynamics, in A New Guide to Post Keynesian Economics (ed.) R. Holt and S. Pressman, Armonk, NY: M.E. Sharpe, pp. 92–101. Shaikh, A. (2005) Personal communication. Sraffa, P. (1926) The Laws of Return under Competitive Conditions. Economic Journal, 36 (144), pp. 535–550. Tucker, R. (ed.) (1978) The Marx-Engels Reader. New York: W.W. Norton. Walsh, V. and Gram, H. (1980) Classical and Neoclassical Theories of General Equilibrium. New York: Oxford University Press.

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The theoretical and political importance of the economics of Keynes Or, what would Marx and Keynes have made of the happenings of the past 30 years and more?* Geoff Harcourt

Introduction I start with two propositions: first, that Maynard Keynes and Karl Marx, were they still with us, would have made far more sense of the happenings of modern capitalism of the past 30 to 40 years than do the more modern approaches to macroeconomics of the same period; and, second, that Keynes would have sat down and tried again to save capitalism from itself. (Marx may have rubbed his hands and hoped that its demise, so often predicted by him and his followers, was at last on hand – but I would not bet on this.) It may surprise you that I couple Keynes and Marx together, but I would argue – the evidence is supplied in a fine book by Claudio Sardoni (1987) – that when Marx and Keynes examined the same issues in the capitalist process, they came up with much the same answers. Perhaps, on further reflection, this should not be surprising, for along with Michal Kalecki and Joseph Schumpeter (said by Joan Robinson to have been Marx with the adjectives changed), they have made the deepest, most insightful analyses of the laws of motion of capitalist society in our profession.1

Modern macro and its limitations I shall say more about their analyses below. First, let me clear out of the way why I think the modern approaches are less than satisfactory: they employ either representative agent models, or Frank Ramsey’s benevolent dictator model, or an emphasis on certain imperfections in the workings of capitalist institutions, such as are to be found in New Keynesian models – sticky wages and prices, imperfectly competitive market structures, asymmetrical information, and the like. Modeling the economy as a representative agent rules out by assumption one of the fundamental insights of Keynes (and Marx), to wit, the fallacy of composition, that what may be true of the individual taken in isolation is not necessar-

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ily true of all individuals taken together. This implies that when looking at the macroeconomic processes at work in capitalism, we cannot presume that the whole is but the sum of the parts. Indeed it is not. We have, therefore, to consider the macroeconomic foundations of microeconomics as James Crotty (1980), citing Marx, told us long ago, and on which Frank Hahn, innocent of all this, is now working. Wynne Godley also has been working most innovatively on this theme for many years. Moreover, that great and wise Keynesian, Lorie Tarshis, regarded the use of the representative agent as the greatest heresy of modern macroeconomics and explained why in Tarshis (1980); see also Harcourt (1995, 2001a). As for Ramsey’s benevolent dictator model, a re-read (or a read for the first time) of his classic 1928 article “A Mathematical Theory of Saving,” together with his own scathing assessment of it,2 ought to show how fanciful it is to argue that, in a completely different setting, it could illuminate what has been happening in actual interrelated modern economies in recent decades or, in fact, any decades. As for the New Keynesians, while it is possible to applaud many of their policy conclusions and make common cause with them on them (a plea I first made in a 1980 paper that was not published until 1996; see Harcourt, 1996–97, 2001a), I submit that their policies do not always follow logically from their theories. By basing their results on imperfections, they imply that if the latter were not there in the first place, or were to be removed, all would be well. But as Marx and then Keynes argued, freely competitive capitalism with power diffused equally between all individual decision-makers and those affected by such decisions, especially wage-earners, so that, in effect, no one individual has any power, still would not work in an optimal manner. In particular, it would not necessarily provide full employment of labor and capital either in the short or the long period, so that booms and depressions, inflations and deflations, and, in certain circumstances, deep crises could still be the order of the day. An especially astute argument for an aspect of this set of arguments is to be found in Nina Shapiro’s 1997 paper, “Imperfect Competition and Keynes.”3 She argues plausibly that an economy characterized by freely competitive market structures would have cycles of greater amplitudes and higher average levels of unemployment over time than one characterized by imperfectly competitive market structures. This insight is shared both by her contemporaries, for example Paul Davidson and Jan Kregel, and by distinguished predecessors like Austin Robinson, who always lamented the relative lack of interest by Keynesians in the early postwar years in the systemic effects of market structures, regional experiences and requirements, and the like, Michal Kalecki, whose review of The General Theory4 forcefully makes this point in his usual lucid and succinct way, and John Kenneth Galbraith in his greatest classic, The New Industrial State (1967). All these economists, together with Marx and Keynes, were analyzing how key decisions made in an environment of inescapable uncertainty impact on systemic behavior. The thrust of Austin Robinson’s, Galbraith’s, and Shapiro’s argument is that anything that reduces the impact of uncertainty on firms’ decisions on the

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production, employment, and, most importantly, accumulation5 is likely to result in more satisfactory and stable systemic behavior. Especially is it likely to beget a higher rate of accumulation on average and so a greater chance of absorbing (offsetting) the level of saving associated, if not with full employment levels of income, at least with high levels, certainly higher levels than would occur in a system characterized by the Marshallian freely competitive structures that Keynes used most of the time in The General Theory itself. Though the New Keynesians have mounted vigorous and, to my mind, telling counterattacks on the New Classical Macroeconomics within the latter’s own framework (see, for example, Hahn and Solow, 1995), they have not themselves completely escaped from the clutches of what Joan Robinson (1964) once aptly dubbed “Pre-Keynesian Theory after Keynes.” It is true that they have routed the extreme idea associated with the beginning of the use of the hypothesis of rational expectations by the New Classical macroeconomists that the world may be analyzed as if perfect competition and perfect foresight reigned so that the Arrow–Debreu model could be used as the base on which to erect theory and policy. And it is also true that the rational expectations hypothesis, when it is uncoupled from the Lucas vertical aggregate supply curve, is just a hypothesis deserving to be tested. Indeed, if it were found not to be inconsistent with the facts, and if the world is correctly illuminated by Keynes’s model, coupling them together would serve to reinforce policies of intervention, for then thinking alone could make it so, as it were. Yet, having cheered all this, there are still so many remnants of what Keynes dubbed classical economics present in the New Keynesian approach as to make it logically unacceptable as the appropriate model or even “vision” for starting an analysis of the modern world: that is to say, a world in which foreign exchanges have been floated, sometimes dirtily, often freely, financial markets have been deregulated, credit has been made “available to all,” capital controls have been removed in many economies, labor markets have been made flexible (a euphemism for making the sack effective again by re-creating the reserve army of labor after the full employment years of the long boom as the Marxists have it or Golden Age of capitalism as the Left Keynesians dubbed it), international trade has been liberalized at least in some directions, often at the expense of the South and to the benefit of the North, and technical advances have reduced the length of the short run in financial and other markets to hours rather than weeks or months. For it is not obvious that the equilibrating mechanisms of supply and demand (even if associated with path dependence) with their underlying theme of harmony, balance, and voluntary choice are universally the appropriate tools to use.6 So let us reiterate the essential lessons that Keynes taught us.

Essence of Keynes I briefly sketch what I have come to believe is the essence of Keynes’s new position, as he saw it himself in 1936 and 1937, the culmination of his journey from A Tract on Monetary Reform (1923) through A Treatise on Money (1930)

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to The General Theory7 I do not give chapter and verse for what I have to say; it is based on my reading over many years of The General Theory and Keynes’s other books, the Collected Writings (1971–79), and much secondary literature, especially in recent years Robert Skidelsky’s superb three-volume biography of Keynes (Skidelsky, 1983, 1992, 2000). The essential characteristics of the Marshallian system as Keynes viewed it was, first, the domination of the long period and, second, a strict distinction between the real and the money. In the real system, supposing there to be free competition, the object of the analysis was to determine long-period normal equilibrium prices and quantities, using partial equilibrium supply and demand analysis (but showing in an appendix that the same principles apply in a general equilibrium system, to wit, that equilibrium prices were, as we say now, marketclearing). The analysis was as applicable to the markets for the services of productive factors as it was to the market for commodities. As for the process of accumulation, there was a supply of real saving, consumption foregone, associated with maximizing expected utility choices between present and future consumption, with the rate of exchange reflecting time preference at the margin; and a demand for saving, investment, in which the technical possibilities of transforming present consumption into future consumption at the margin were the key concepts. The price which cleared this market and set the composition of the national income between consumption and saving/investment was the natural rate of interest, a real concept. The general equilibrium version would have as a corollary the Say’s Law level of long-period overall output, itself a “simple” summation of the individual quantities of commodities (and employment) associated with the long-period market-clearing prices of individual markets. So what determined overall employment (and zero, non-voluntary, unemployment) was not an interesting theoretical question, if it were ever even to be asked: only simple summation was required. When we come to the discussion of the determinants of the general price level – so far only relative prices and quantities have been discussed, neither money nor money prices played any significant analytical role – the quantity theory of money tautology could easily be turned into a theory. For if M was determined by the monetary authorities, V was given by institutions and historical customs and T was interpreted as the total of transactions associated with the Say’s Law long-period equilibrium position, P remained the only unknown. Moreover, if V and T were given, changing M would, at least as a long-period tendency, change P in the same proportion. (Keynes would have expressed all this in terms of the Marshallian/Cambridge version of the quantity theory but the story is essentially the same.) Money, therefore, was only a veil in the long period. The object of volume II of an ideal Principles of Economics was to set out this basic theory, analyze the causes of fluctuations around the long-period position (the trade or business cycle), and design institutions which either allowed the economy to return as quickly as possible to the equilibrium position after a

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shock, or to move as painlessly as possible to a new equilibrium position if the basic real determinants of it – tastes, endowments, techniques of production – themselves changed. The essential task of the monetary authorities was to ensure that the money rate of interest was consistent with the underlying natural rate of interest which, like saving, ruled the roost in the process of accumulation. This, in the crudest, simplest form, was the system on which Keynes was brought up, as he came to see it. Because of the real/monetary dichotomy, and because he was writing on money, Keynes felt inhibited about spending time on the intricate happenings to output and employment in the short period and over the cycle – “the intricate theory of the economics of the short period.” Nevertheless, in A Tract he recognized them and especially the evils of unemployment and deflation – hence he cheeked Marshall about our mortality in the long run – but, analytically, he was looking for institutions and their behavior which would give price stability and allow the economy to settle at its long-period Say’s Law position. In A Treatise on Money he presented the famous banana plantation parable but he was unable analytically to stop the downward spiral of activity and prices until either the inhabitants had starved to death or there was an ad hoc change in their accumulation behavior (Keynes, 1930, pp. 158–60). The endogenous process and its end had to wait for the publication of Kahn’s multiplier article in 1931 which also contained “Mr. Meade’s Relation” – the derivation of the value of the multiplier by concentrating on the leakage into saving. In The General Theory, Keynes (1936) replaced the old system by a radically new, indeed revolutionary, system. As a Marshallian his basic tools were demand and supply functions, now aggregate ones. His emphasis was on the short period in its own right, suitably adapted for analysis of the economy overall. (This had been the emphasis, too, in Kahn’s 1929 Fellowship dissertation on The Economics of the Short Period, though Kahn’s analysis was microeconomic.) The dichotomy between the real and the money disappeared in both the short period and the long period (which Keynes ultimately ceased to believe to be a coherent concept in macroeconomics). Money and other financial assets and monetary institutions entered the analysis from the start (institutions were only sketched relatively to the rich analysis in A Treatise on Money, a deliberate choice by Keynes). Aggregate planned expenditures drove the system which operated in an environment of inescapable uncertainty. The latter had inescapable consequences for vital decisions, especially regarding investment expenditures and the holding of money and other financial assets. Investment dominated and saving responded through the consumption function. The consumption function was, of course, the relationship between aggregate disposable income and the distribution of income between the classes, on the one hand, and planned consumption expenditure, on the other. Keynes intimately related it to the (income) multiplier through the marginal propensity to consume. The amount saved (but not the form in which it was held) was treated as a residual. Investment was determined by expected profitability, on the one hand, and the money rate of interest, representing the alternative ways of holding funds (and

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their availability and cost), on the other. Subsequently, in 1937, finance, especially through the banking system and the stock exchange, was also to play a vital role as, cet. par., the ultimate constraint on investment expenditure. The money rate of interest therefore ruled the roost and the expected rate of profit (the marginal efficiency of capital, the counterpart to the natural rate of interest in the old system) had to measure up to it. The money rate of interest was depicted as the price which cleared the money market by equating the demand for money with its supply, not as the (real) price which equalized desired saving and investment. The rest state in both the short period and the long period could be associated with involuntary unemployment – people willing to work in existing conditions but with the level of aggregate demand such as there not to be sufficient demand for their services. Nor was there any effective way for them to signal that it would be profitable to employ them; indeed, there would be no profitable way to employ them unless there were to be a rise (or an expected rise) in real expenditures. Up to full employment, the outcome in the labor market depended on what happened in the commodity market. The quantity theory was replaced as an explanation of the general price level by old-fashioned Marshallian short-period competitive pricing, suitably (or perhaps not) adapted to the economy as a whole. There were therefore at least three 180º turns between the old and the new: investment dominated saving, the commodity market dominated the labor market and the money rate of interest dominated the expected rate of profit. The forces which would make planned accumulation even on average absorb full employment saving were unreliable and weak, not to be relied on even as tendencies. Moreover, the general price level was determined by factors other than the quantity of money.

Keynes’s post-General Theory developments The new system was the base on which Keynes would build his theory of inflation in How to Pay for the War (1940) and his policy proposals for the international world order in the postwar period. In a superb review article on the third volume of Skidelsky’s biography of Keynes (Skidelsky, 2000), David Vines (2003) makes a convincing case for the proposition that Keynes provided the conceptual basis for modern international macroeconomic theory. Of course this is not to be found explicitly in The General Theory itself. That book was mainly concerned with a closed economy model in order to highlight the central theoretical propositions and insights of the new theory. Nor did Keynes analyze the trade cycle or long-term growth issues systematically in The General Theory, and some of his obita dicta asides look rather strange now. For most of The General Theory Keynes was content to discuss existence and stability propositions in the short period, focusing especially on the factors that were responsible for the point of effective demand at which aggregate demand and aggregate supply, and planned investment and planned saving (more generally, injections into and leakages from the expenditure-production-income

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circuit) were equalized. (He said later that if he were to write the book again he would have been more careful to separate out the fundamental factors responsible for the existence of the point of effective demand from the other set responsible for stability and reaching the point through a groping process by business people. He thought that Ralph Hawtrey had confused the two. See Keynes, CW, XIV, pp. 181–82.) In his starkest model, one designed not so much to describe the world as it is, but to bring out most simply what was at stake, he assumed, as Jan Kregel (1976) has told us, that short-term expectations concerning immediate prices, sales, costs, et al. were always realized and were independent of long-term expectations concerning their future courses, the ingredients most relevant for investment decisions, so that planned investment could provisionally be taken as a given and the point of effective demand established immediately. In his most sophisticated model of (the same) reality, the independence of the two sets of expectations was scrapped, the point of effective demand was not realized immediately and indeed it changed over time as the model of shifting equilibrium came into play. This last apparatus is in rudimentary form the starting point for the development of growth theory by Richard Kahn and Joan Robinson, Nicky Kaldor and Luigi Pasinetti, and the models of cyclical growth developed by Kalecki (independently) and Richard Goodwin. Both Marx and Keynes recognized that when financial capital was not moving in tandem with industrial and commercial capital (Marx would and Keynes would not have put it this way), malfunctions and sometimes crises were likely to occur. Keynes set out his ideas on this in, for example, the key chapter 12 of The General Theory on the operation and non-operation of the stock exchange and its relationship to real accumulation and activity generally. Another key step was in his 1937 (Keynes, 1937a and 1937b) papers on the rate of interest and the finance motive, which discuss how the banking system in particular holds the key to the realization of investment plans, taking as given the state of long-term expectations. The stock exchange also has a key role because the repayment of the bank loans used to finance the setting up of investment projects, the start of the process of accumulation, depends upon the firms concerned being able subsequently to place new issues of shares and debentures at satisfactory prices. (The demand for the new issues comes, in part at least, from the placement of the new saving created by the new investment.) The point is that finance and saving are sharply separated by their roles and place – timing – in the process of accumulation. These ideas were subsequently developed by Hyman Minsky in particular, writing under the rubric of his financial instability hypothesis. Minsky spelled out ideas, perhaps more implicit than explicit in the writings of Keynes and Dennis Robertson, suggesting that the natural, probably inescapable, cyclical movements on the real side of the economy can be amplified both upwards and downwards by events in the financial aspects of the economic process. Minsky stressed the feedbacks associated with the disparities between expected cash flows and actual or realized cash flows in the accumulation/production process,

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and emphasized how non-realization acts on confidence and expectations, stoking the boom in its early stages, accelerating the downturn and deepening and prolonging the subsequent recession or depression.8

Marx and Keynes’s insights applied to the monetarist episode As well as pointing out the implications of disparities in the progress of finance capital in relation to commercial and industrial capital, Marx’s analysis of the inherent contradictions in capitalism are of immediate relevance for our purposes in this chapter. Unlike Keynes, Marx made a clear distinction between happenings in the sphere of production, on the one hand, and happenings in the sphere of distribution and exchange, on the other. As far as the possibility of and limits to accumulation are concerned, it is conditions in the sphere of production – the length and intensity of the working day, the state of the class war between capital and labor, employer and employee – that ultimately determine the size of the potential surplus created for the realization of profits and for future accumulation. Whether this potential is realized or not, though, depends upon happenings in the other sphere of distribution and exchange. It is here that Keynes, Kalecki, and developments based on their contributions come into play: the combination of the theories of investment and of the distribution of income determined by the expanded version of the theory of effective demand decides how much of the potential surplus is realized in actual profits and accumulation (see, for example, Harris, 1978). These ideas help to explain one of the paradoxes of recent decades. Monetarism has rightly been called by the late Thomas Balogh (1982) “the incomes policy of Karl Marx.” Ostensibly, the theory was meant to justify policies designed to rid the system of inflationary tendencies. In fact, it was associated with the attempt to swing the balance of economic, social, and political power back from labor to capital. (The reverse swing had occurred cumulatively in many advanced capitalist economies during the years of the long boom.) The means to this end was the re-creation of the reserve army of labor, so making the sack an effective weapon again and creating cowed and quiescent workforces and greater potential surpluses for national and, increasingly, international capital accumulation. What was not realized was that the emergence of heavy and sustained unemployment, ostensibly to push short-run rates of unemployment above so-called natural rates and then let them converge on natural rates where inflation could be sustained at steady rates and accelerating rates of inflation would be things of the past, would simultaneously have such an adverse effect on what Keynes called the “animal spirits” of business people, the ultimate determinants of rates of accumulation. Hence we have had decades in many economies in which inflation has been drastically reduced yet accumulation has been sluggish, certainly well below the levels needed to offset full-employment saving and below the levels achieved during the long boom itself. In those countries where this had

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not occurred, despised Keynesian policies have continued to be used, sometimes unintelligent ones such as those implemented, for example, during the last six years of Ronald Reagan’s Presidency in the USA and now by President Bush the Second. Since attaining full employment by the use of fiscal policies was no longer on the agenda in the former countries and monetary policies were mainly directed at general price levels and exchange rates, contractionary forces were widely prevalent in these countries, as the politicians and their advisors waited (or claimed to be waiting) in vain while the impersonal forces of competitive markets allied with monetarist rules allowed the economies to seek and find their natural rates.

“Visions” and policies It is fair to say that Keynes never completely threw off the vision of the working of economies in terms of an equilibrium framework. He did, of course, argue that government intervention was needed to help attain a satisfactory full employment equilibrium (internal balance) in each economy. This was an essential step towards equilibrium associated with external balance in the international system and the possibility then to take advantage of the classical principles of free trade on which he had been brought up.9 The proposals he put forward at Bretton Woods were designed to provide the institutions and the liquidity that would make all this possible. That the Americans, principally through Harry Dexter White, won out on both the institutions and the provision of liquidity adopted for the postwar period was a tragedy; for this ensured that the Bretton Woods system contained within it the seeds of its own eventual destruction from its very inception. (How Marx would have laughed!) One of the major changes in vision since Keynes’s death about how markets, economies, even whole systems work, associated with Keynes’s followers, especially Kaldor and Joan Robinson, is the concept of cumulative causation. The concept has its origins in Adam Smith (what has not?) and was brought into prominence in the modern era by Allyn Young (1928), Kaldor’s teacher at the LSE, and subsequently championed by Kaldor and independently by Gunar Myrdal. The way I illustrate the essential idea of the concept for my students is through the analogy of a wolf pack (I am not a zoologist so I may be completely wrong about how wolves behave; but as I am an economist, at least I think so, let us assume I am right). There are two major views on the workings of markets, economies, whole systems. The dominant one is that akin to a wolf pack running along. If one or more wolves get ahead or fall behind, powerful forces come into play which return them to the pack. (The parallels with the existence of an equilibrium that is stable, and that the forces responsible for existence are independent of those responsible for stability are, I hope, obvious.) The other view has the forces acting on the wolves who get ahead or fall behind make them get further and further ahead or fall further and further behind, at least for long periods of time. This view captures the notion of virtuous or

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vicious processes of cumulative causation. Which view is “correct” makes a drastic difference to our understanding of the world and how specific policies are perceived, recommended and evaluated. I illustrate with an example, the case for freely floating exchange rates. A classic paper arguing for them is by Milton Friedman (1953). Underlying his argument is the first wolf pack analogy, that in a competitive setting there exists a set of long-period stable equilibrium exchange rates that quickly would be found and then kept more or less in place by a free float. In this setting the systemic effects of speculation would be beneficial, for speculators with their superior knowledge, intelligence, and information would help the system to reach the equilibrium pattern more quickly than in their absence and then sustain it there. But suppose that the second wolf pack analogy is the correct or at least more correct description of how foreign-exchange markets work. Then there is no set of stable equilibrium exchange rates “out there” waiting to be found and now a float combined with speculative activity will be systemically harmful, accelerating the movements away in both directions of exchange rates away from one another and also of systems, at least for long periods of time. I submit that the second scenario is more akin to what has happened over much of recent decades, and provides a rationale for various schemes suggested to curb the action of speculators. (My own suggestions may be found in Harcourt (1994, 1995, 2001b). I had generalized the Tobin tax proposal without, I must confess, being aware at the time of its existence!) It is not only in markets characterized by processes of cumulative causation processes that speculation may be systemically harmful. Any market in which stocks dominate flows and expectations about the behavior of other participants in the market dominate the more usual economic factors – preferences, cost of production – in the setting of prices may experience periods when speculation is harmful.10 An obvious example is the stock exchange. On this we may recall Keynes’s famous description in Chapter 12 of The General Theory of what may happen when “enterprise becomes a bubble on a whirlpool of speculation” (Keynes, 1936, p. 159).

A post-Keynesian solution to Kalecki’s dilemma? Let me close with another example of how Keynes and Keynesian/Kaleckian/ Marxian ideas are still relevant for both our understanding and policy-making. The ideas I present now are based on Kalecki’s famous 1943 paper “Political Aspects of Full Employment” and the writings of my two greatest Australian mentors, the late Eric Russell (Meade and Russell, 1957; Russell, 1965) and the late Wilfred Salter (1960), both devoted Keynesians; see Harcourt (1997, 2001b) for the arguments and references. Kalecki set out graphically the vital difference between the political economy of getting to full employment after a deep slump, when all classes are in favor of this, the wage-earners in order to get jobs, business people in order to receive higher profits, the government in order to reduce the risk of serious social unrest,

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on the one hand, and the political economy of sustaining full employment, on the other hand. In conditions of sustained full employment, as I argued above, there is a cumulative shift of economic, social, and political power from capital to labor. The capitalist class, indeed conservative elements generally, get more and more uneasy about the emerging situation. An environment is created in which, for example, monetarist ideas will be well received, and more than one economist will be prepared to be a hired prize fighter in support of those ideas as guides to government (and central bank) actions. Is there an answer to this, on the face of it, inescapable dilemma in our sorts of economies? Keynes and his followers recognized that attaining and then maintaining full employment would carry with it cumulatively rising inflationary pressures associated with rising money-wage demands. It is no accident that Joan Robinson always said that, from 1936 on, “Incomes Policy” was her middle name, a perceptive insight no doubt reinforced by having an actual middle name of Violet. Russell and Salter recognized this dilemma and argued in Australia for a full-employment policy that included an incomes policy implemented through our centralized wage-fixing body (then the Australian Arbitration Commission). In broad outline, at a starting point, money incomes were to be adjusted periodically for changes in prices and in overall productivity. Not only is this adjustment equitable, it is also efficient. It is equitable because at the level of the economy as a whole, capital and labor are complements and the impact of their combined activity on overall productivity ought to be reflected in changes in the real incomes of all citizens. It is efficient because with full employment, such an overall policy discourages low productivity, often declining industries whose time has passed and encourages high productivity, often expanding industries whose time has come. The result is a regime with higher increases in overall productivity than would occur otherwise, certainly than would occur in a regime characterized by so-called flexible labor markets, such as are the UK’s and the USA’s pride and joy. There would be therefore an agreeable quid pro quo for money income restraint in the form of rising real incomes, so providing a possible solution to Kalecki’s dilemma. There are, of course, all sorts of qualifications and modifications and exceptions to the starting rule – I discuss these in the article referred to above. Here I wanted to set out the core argument as starkly as possible.

Conclusion In conclusion, I want to say that Keynes and his ideas are still alive and well; that subsequent developments by others complement agreeably his own revolutionary contributions; and that people of goodwill who wish to see established just and equitable societies worldwide have in these ideas an essential starting point.

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Notes * A lecture originally given at the conference on “Keynes and After,” held at the Faculty of Economics and Business Administration, University of Iceland, Reykjavik, on October 10, 2003. I thank the organizers for allowing me to publish it as a chapter in this volume. I am most grateful to the editors of the book for their helpful comments on a draft of the chapter. I would also like to pay tribute to Ingrid Rima for many years of friendship, support, and inspiration. 1 Marx’s views on socialism are another matter altogether; see Harcourt and Kerr (2001). 2 In a letter to Keynes (June 28, 1928) when he submitted the article to the Economic Journal, he wrote: “Of course the whole thing is a waste of time.” It had distracted him from “a book on logic . . . [because] it [was] much easier to concentrate on than philosophy and the difficulties that arise rather [obsessed him].” 3 Fairness demands that I refer the reader to Robin Marris’s paper, “Yes, Mrs. Robinson! The General Theory and Imperfect Competition” that immediately precedes Shapiro’s paper in Harcourt and Riach, vol. 1 (1997). Marris argues that Keynes-type results only go through with imperfectly competitive microeconomic foundations. 4 Kalecki’s review, though published in Polish in 1936, was not available in full in English until 1982; see Targetti and Kinder-Hass (1982). 5 The firm is the most fundamental unit of analysis in Keynes’s macroeconomics, a point emphasized repeatedly by Tarshis, one of Keynes’s most devoted pupils and disciples; see Harcourt (1995, 2001a). 6 Steven Pressman (November 9, 2004) chides me for being “a little harsh on New Keynesian economics and a bit unfair to them. First, in part, New Keynesian economics was an attempt to beat rational expectations at its own game. This can explain some of the ‘pre-[Keynesian]’ side to it that [I] object to.” I thought I had said that when citing Hahn and Solow (1995) above. Second, he reminds me that “there are many strands of New Keynesian economics that are more Keynesian or Post Keynesian than neoclassical.” He cites Joe Stiglitz’s work (with Weiss) on “credit rationing,” for example (Stiglitz and Weiss, 1981). But Stiglitz’s ideas were anticipated by Kalecki in 1937 with his principle of increasing risk, an acknowledgement that Stiglitz only made towards the end of his series of articles on the issue. So, having rethought as asked, I’m really not that repentant! 7 Perhaps we should start from A Treatise on Probability (1921) and The Economic Consequences of the Peace (1919) as important insights from them are to be found in his later views and theories. 8 For some policy implications of Minsky’s insights, see Harcourt (2001a, ch. 15). 9 Skidelsky (1992, p. xv) called him “the last of the great English liberals.” 10 The seminal and classic paper on this is Kaldor (1939).

References Balogh, T. (1982) The Irrelevance of Conventional Economics (London: Weidenfeld & Nicholson). Crotty, J.R. (1980) “Post-Keynesian Theory: An Overview and Evaluation,” American Economic Review, 70, pp. 20–25. Friedman, M. (1953) “The Case for Flexible Exchange Rates,” in Essays in Positive Economics (Chicago: University of Chicago Press). Galbraith, J.K. (1967) The New Industrial State (Boston: Houghton Mifflin). Hahn, F. and Solow, R. (1995) A Critical Essay on Modern Macroeconomic Theory (Oxford: Blackwell).

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Harcourt, G.C. (1994) “A ‘Modest Proposal’ for Taming Speculators and Putting the World on Course to Prosperity,” Economic and Political Weekly, 29, pp. 2490–92; reprinted in Harcourt (2001b). Harcourt, G.C. (1995) “Lorie Tarshis, 1911–1993: An Appreciation,” Economic Journal, 105, pp. 1244–55; reprinted in Harcourt (2001a). Harcourt, G.C. (1996–97) “Critiques and Alternatives: Reflections on Some Recent (and Not So Recent) Controversies,” Journal of Post Keynesian Economics, 19, pp. 171–70; reprinted with an Addendum in Harcourt (2001a). Harcourt, G.C. (1997) “Pay Policy, Accumulation and Productivity,” Economic and Labour Relations Review, 8, pp. 78–89; reprinted in Harcourt (2001b). Harcourt, G.C. (2001a) 50 Years a Keynesian and Other Essays (Houndmills, Hants.: Palgrave). Harcourt, G.C. (2001b) Selected Essays on Economic Policy (Houndmills, Hants.: Palgrave). Harcourt, G.C. and Kerr, P. (2001) “Karl Marx, 1818–83,” in Harcourt (2001a). Harcourt, G.C. and Riach, P.A. (eds) (1997) A “Second Edition” of The General Theory, 2 vols (London: Routledge). Harris, D.J. (1978) Capital Accumulation and Income Distribution (Stanford: Stanford University Press). Kahn, R.F. (1929) The Economics of the Short Period (London: Macmillan, 1989). Kahn, R.F. (1931) “The Relation of Home Investment to Unemployment,” Economic Journal, 41, pp. 173–98. Kaldor, N. (1939) “Speculation and economic stability,” Review of Economic Studies, 7, pp. 1–27; reprinted in Kaldor (1960). Kaldor, N. (1960) Essays in Economic Stability and Growth (London: Duckworth). Kalecki, M. (1937) “Principle of Increasing Risk,” Economica, 16, pp. 440–46. Kalecki, M. (1943) “Political Aspects of Full Employment,” Political Quarterly, 14, pp. 322–31. Keynes, J.M. (1919) The Economic Consequences of the Peace (London: Macmillan). Keynes, J.M. (1921) A Treatise on Probability (London: Macmillan). Keynes, J.M. (1923) A Tract on Monetary Reform (London: Macmillan). Keynes, J.M. (1930) A Treatise on Money, 2 vols (London: Macmillan). Keynes, J.M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). Keynes, J.M. (1937a) “Alternative Theories of the Rate of Interest,” Economic Journal, 47, pp. 241–52; reprinted in CW, XIV. Keynes, J.M. (1937b) “The ‘Ex-Ante’ Theory of the Rate of Interest,” Economic Journal, 47, pp. 663–69; reprinted in CW, XIV. Keynes, J.M. (1940) How to Pay for the War (London: Macmillan); reprinted in CW, XXV. Keynes, J.M. (1971–79) The Collected Writings of John Maynard Keynes, Vols I–XXIX (London: Macmillan); cited here as CW followed by volume number. Kregel, J.A. (1976) “Economic Methodology in the Face of Uncertainty: The Modelling Methods of Keynes and the Post-Keynesians,” Economic Journal, 86, pp. 209–25. Marris, R.L. (1997) “Yes, Mrs. Robinson! The General Theory and Imperfect Competition,” in Harcourt and Riach (1997), vol. 1. Meade, J.E. and Russell, E.A. (1957) “Wage Rates, the Cost of Living and the Balance of Payments,” Economic Record, 33, pp. 23–28.

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Ramsey, F. (1928) “A Mathematical Theory of Saving,” Economic Journal, 38, pp. 543–59. Robinson, J. (1964) “Pre-Keynesian Theory after Keynes,” Australian Economic Papers, 3, pp. 25–35. Russell, E.A. (1965) “Wages Policy in Australia,” Australian Economic Papers, 4, pp. 1–26. Salter, W.E.G. (1960) Productivity and Technical Change (Cambridge: Cambridge University Press). Sardoni, C. (1987) Marx and Keynes on Economic Recession (Brighton: Wheatsheaf). Shapiro, N. (1997) “Imperfect Competition and Keynes,” in Harcourt and Riach (1997), vol. 1. Skidelsky, R. (1983) John Maynard Keynes, Volume One. Hopes Betrayed, 1883–1920 (London: Macmillan). Skidelsky, R. (1992) John Maynard Keynes, Volume Two. The Economist as Saviour, 1920–1937 (London: Macmillan). Skidelsky, R. (2000) John Maynard Keynes, Volume Three. Fighting for Britain, 1937–1946 (London: Macmillan). Stiglitz, J.E. and Weiss, A. (1981) “Credit Rationing in Markets with Imperfect Competition,” American Economic Review, 71, pp. 393–410. Targetti, F. and Kinda-Hass, B. (1982) “Kalecki’s Review of Keynes’ General Theory,” Australian Economic Papers, 21, pp. 244–60; Kalecki’s review, “Some Remarks on Keynes’ Theory,” is pp. 245–53. Tarshis, L. (1980) “Post-Keynesian Economics: A Promise that Bounced?,” American Economic Review, 70 (May), pp. 10–14. Vines, D. (2003) “John Maynard Keynes 1937–46: The Creation of International Macroeconomics,” Economic Journal, 118, pp. F338–F361. Young, A. (1928) “Increasing Returns and Economic Progress,” Economic Journal, 38, pp. 527–42.

5

Profit maximization in the Cambridge tradition of economics Maria Cristina Marcuzzo and Eleonora Sanfilippo*

Introduction Since the 1960s, the ‘Cambridge’ approach has been increasingly identified with the anti-marginalist stance, be it of a Sraffian or a Kaleckian lineage. We produce evidence, however, that at least until the 1950s, consensus among the leading Cambridge economists hardly existed on this matter. Keynes and Kahn never rejected Marshall’s language when dealing with price and output determination by the single firm. They, and Joan Robinson, were highly critical of the concept of degree of monopoly, employed by Kalecki who, on his part, while rejecting the Marginal Revenue  Marginal Cost approach, was unsympathetic to full-cost pricing, at least in the form suggested by Hall and Hitch (1939). Unlike Sraffa’s case, the critique that Keynes, Kahn and Joan Robinson raised against the neoclassical paradigm and the supposed optimality of the system went together with the apparently unquestioned acceptance by them – at least at a disaggregate level – of marginal analysis, supply and demand theory, and the related concept of equilibrium.1 On the other hand, these economists never endorsed that theory in the case of investment decisions and money market operations, because of the role they attributed to uncertainty and the importance they all gave to the unpredictable consequences, at the aggregate level, of individuals’ intertemporal choices. In what follows, we examine the positions taken by Marshall, Kahn, and Keynes on marginal cost pricing and profit maximization, and the criticisms put forth by Kalecki and the Cambridge Keynesians against the Hall and Hitch version of full-cost pricing. Although Marshall and Kahn were more concerned with the equilibrium of the individual firm or industry, while Keynes and Kalecki were addressing these issues in the context of the system as a whole, we compare their approaches to entrepreneurial behaviour – as summarized in the assumption of profit maximization2 – to clarify the reasons underlying the acceptance or rejection of that assumption. In order to avoid confusion, some clarifications are needed. In the title, and throughout the chapter, we make reference to a not clearly specified Cambridge tradition and the reader may wonder why these particular authors have been selected. We give two reasons: the first, less controversial, is that they

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are leading economists within the Cambridge approach; the second is that they seem, at least on the surface, hesitant to endorse the marginal method in their analysis. Indeed, if we were to address the question of what is the Cambridge tradition, as far as the theory of business behaviour is concerned, our attention should be directed rather to those authors such as Macgregor, Lavington, Robertson, and Andrews or to those parts of Marshall’s works, such as Industry and Trade (1919), which deal extensively with these issues and stand out as the Cambridge approach to industrial economics (Raffaelli, 2004). However, as we hope to make clearer below, this is not the purpose of the present chapter, which explains also why we do not pursue our inquiry into those aspects of Marshall’s approach which point to directions other than the static marginal analysis of the entrepreneur’s behaviour. On the contrary, it is our purpose to address the question of whether, and to what extent, the profit maximization rule was adopted by authors who are taken as reference points in the search for an alternative to mainstream economics. It should also be made clear that our aim is not to set up an agenda for the task of reconstructing a Cambridge (or Post Keynesian) approach to business behaviour, but rather to delineate as precisely as possible the positions held by those authors, in what is mainly an exercise in the history of economic thought. In this respect, we do not even attempt to address the question of how entrepreneurs behave in the real world, although we hold the view that profit maximization and marginal calculus are neither a convincing nor a logically tight representation.

Marshall Marshall is the starting point of our investigation, since he was extremely influential in the development of many lines of research within the Cambridge tradition in economics that were pursued by his followers and critics alike. In the recent literature, the view has emerged that the evolutionary approach, as can be found in Industry and Trade and in some parts of the Principles, is the essential element of Marshall’s theory of the individual firm and industry, in general.3 It is claimed that the standard interpretation – the static analysis of various types of cost, the supply and demand apparatus, as presented in Book V, Chapter VI, of the Principles – is misleading and gives a false image of what Marshall was trying to do (Dardi, 2003; Raffaelli, 2003). Even in the light of these recent interpretations, what seems difficult to deny is the presence in Marshall’s analysis – beyond an evolutionary/biological approach – of a static vision of the firm, in which the entrepreneur is seen as a maximizing agent whose behaviour is analyzed in terms of the marginal method. See, for instance, the following passage: Every business man [. . .] estimates as best he can how much net product (i.e. net addition to the value of his total product) will be caused by a certain extra use of any one agent; [. . .]. He endeavours to employ each agent up to

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Even though a context of imperfect knowledge seems to be implicit here, the marginal method as comparison between two magnitudes at the margin is adopted by Marshall as the rule of behaviour guiding the entrepreneur in his decisions. On the other hand, Marshall’s analysis of the decision process of the entrepreneur in the Introduction of the Principles, as well as in Industry and Trade, appears rather different. A much greater importance in the study of businessmen behaviour is given to the influence of habits and customs, to the institutional context and to business ‘connections’ (see, for example, Marshall, 1919, p. 196), meaning an extended knowledge of the market in which the business man is operating, in all its technical and interpersonal aspects (see Becattini, 1962; Caldari, 2001). The entrepreneur is the ‘undertaker’, that is the person bearing the risk embodied in business activity, and possessing special qualities like ‘knowledge of things in his own trade’, ‘power of forecasting the broad movements of production and consumption’ (which includes the capacity to see ‘where there is an opportunity for supplying a new commodity that will meet a real want or improving the plan of producing an old commodity’), the ability ‘to judge cautiously and undertake risks boldly’ and to be ‘a natural leader of men’ (Marshall, 1920, p. 297; see also Pesciarelli, 1991, and Caldari, 2001).4 In describing the general characteristics of men’s (including businessmen’s) actions, Marshall wrote: [. . .] the side of life with which economics is especially concerned is that in which man’s conduct is most deliberate, and in which he most often reckons up the advantages and disadvantages of any particular action before he enters on it. And further it is that side of his life in which, when he does follow habit and custom, and proceeds for the moment without calculation, the habits and customs themselves are most nearly sure to have arisen from a close and careful watching the advantages and disadvantages of different courses of conduct. (Marshall, 1920, pp. 20–21) In other words, when describing the entrepreneur’s behaviour in the real world the marginal rule becomes a matter of balancing the ‘advantages’ against ‘disadvantages’ of a change in a given situation or action, rather than equalization of two exact magnitudes, such as Marginal Revenue (‘net product’ in Marshall’s terminology) and Marginal Cost, as is the case in the determination of the

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equilibrium of the firm. And it is just this sound representation of the businessman’s decision process which fits well with Marshall’s biological and evolutionary conception of the firm and the economic system as a whole, as the result of processes of repetition and variation, differentiation and integration (Raffaelli, 2003, p. 104). In the Cambridge tradition, we can easily find traces of both representations of the firm and business behaviour. The evolutionary approach permeated the industrial economics as developed by those pupils of Marshall who felt closer to the ‘spirit’ of the Master, such as Lavington, Macgregor, Shove, Robertson and later Andrews (Raffaelli, 2003). In contrast, the static paradigm of the firm in conditions of perfect competition, imbued with supply and demand curves and marginal calculus by entrepreneurs, was enlarged and refined by Pigou and, strangely enough, also by Kahn and Robinson. The theory of imperfect competition sprung up as a reaction to Sraffa’s attack on the Marshallian theory on the ground of its lack of consistency and realism (see Sraffa, 1925, 1926). In the work done first by Richard Kahn and then Joan Robinson, however, imperfect competition became a means to supplement the Marshallian approach rather than a reason to discard it. Perfect competition was shown to be a special case, when supply and demand curves have a particular shape, but the whole marginalist apparatus, embodied in the average and marginal curves and the profit-maximization rule, was fully endorsed (Marcuzzo, 2003).

Kahn In this section we look first at Kahn’s attempts to generalize the Marshallian analysis to cases other than pure competition and, then, at his peculiar interpretation of profit maximization. In his Economics of the Short Period, which is the title of both Kahn’s Fellowship Dissertation (Kahn, 1989) and an unfinished book (Kahn, 1932a), he makes the fundamental point that profit maximization is the general rule for determining the equilibrium level of output, under the assumption of perfect and imperfect competition alike. In an article called the ‘Imperfect Competition and the Marginal Principle’ (Kahn, 1932b), which also remained unpublished during his lifetime,5 Kahn addresses more closely the issue of whether the adherence to the rule is borne out by the observation of actual behaviour of firms. The accordance between theory and reality is reached by interpreting profit maximization rule as synonymous with a method of ‘trial and error’6 rather than a calculus exercise actually and consciously undertaken by businessmen. In the Dissertation he wrote: [. . .] instincts and intuitions will secure adherence to marginal principle in action when conscious apprehension is impossible. And, failing those, we may rely on the method of trial and error; experience, embodied in rule of thumb, will often indicate how profits may be maximised. (Kahn, 1989, p. 162)

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In the article he presented the same argument: [. . .] we can suppose that every producer is, quite independently of the other producers, constantly oscillating his price and output in an attempt to hit off the point of maximum profit. For it is only by relying on the persistent adoption by business men of this method of trial and error that the ordinary assumptions of economic theory can really be justified. (Kahn, 1932b, p. 5) Kahn himself listed the objections which can be raised against his argument. First, how to account for the evidence7 that businessmen usually claim to look at average rather than marginal cost. His answer was that: [. . .] it is the consequences of business men’s individual acts, not of their general theories, with which we have to reckon. And a general theory that appears to them to be completely obvious may fail altogether to gain expression through their individual acts. (Kahn, 1989, p. 159) The point here is that, according to Kahn, businessmen do not behave as they claim they do, and this is why what they say can be disregarded. Moreover, the proof that actual behaviour indeed follows the marginal rule is ‘success’ in business. Second, the demand curve is hardly known by the individual firm. How can it be supposed that it forms the basis for the search of the point of intersection with the marginal cost curve? Kahn claims that what matters is ‘the business man’s conception of his individual demand curve’ arrived at by ‘the method of trial and error’; thus the only relevant assumptions are those ‘that are in the mind of the business man when he maximizes his profit’ (Kahn, 1989, p. 101). In fact, to understand businessman’s behaviour what is relevant ‘is not what actually happens when a firm alters its price, but what the owner of the firm imagines is likely to happen’ (Kahn, 1989, p. 100, emphasis added). Notwithstanding the subjective element embodied in any demand schedule (and in any marginal cost schedule as well), according to Kahn it is possible to employ the demand curve to find the profit maximizing level of output (under perfect competition) and the profit maximizing level of price (under imperfect competition) on the basis of the following argument: [It is] possible to make use of the individual demand curves without presupposing the nature of the assumptions upon which business men act. The nature of these assumptions affects the slope of the individual demand curves and consequently it affects the position of final equilibrium; but it does not affect the general argument by means of which the position of equilibrium can be determined. (Kahn, 1989, p. 119)

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Third, the required assumption of rationality in profit maximization – even if it is interpreted as a trial and error exercise – contrasts with the observation of the dominant influence of inertia on behaviour. For instance, when demand is falling we are likely to find that entrepreneurs are reluctant to apply the marginal rule. Here Kahn stresses that: [. . .] there is a natural inertia which prevents the modification of a policy until other forces have become sufficiently strong to overcome it. Losses are not purposively weighted up against probable future profits, but are allowed to continue until they can be met no longer [. . .] the business man’s innate belief that the organism to which he has devoted so much of his efforts and with which his own existence is so inextricably bound up must again flourish and prosper.8 (Kahn, 1989, p. 23) Moreover, ‘any a business man would rather lose more in order to appear to lose less’ (Kahn, 1989, p. 17). The point here is that rational behaviour, as implied in the application of the marginal rule when output is to be reduced, is not followed by entrepreneurs either because they hold on to ill-founded expectations of recovery, or for fear of appearing unsuccessful. The consequence of not minimizing losses is, however, bankruptcy and/or the closing down of the firm; if firms survive this is proof that the rule was followed. Kahn’s position, as it emerged in his 1930s work, was made popular by Machlup (1946) – with no reference to Kahn, of course, whose views on these matters remained unknown outside the circle of few people in Cambridge – in his famous article ‘Marginal Analysis and Empirical Research’, where he stressed that: 1

2

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Trial and error rather than a strict calculus is the assumed pricing method: ‘The business man who equates marginal net revenue productivity and marginal factor cost when he decides how many to employ need not engage in higher mathematics, geometry, or clairvoyance [. . .] he would simply rely on his sense or his “feel” of the situation’ (Machlup, 1946, p. 535). Demand and cost curves are subjective estimates: ‘Marginal cost and marginal revenue concepts [. . .] refer to expectation of future condition’ (Machlup, 1946, p. 523) and ‘marginal analysis of the firm should not be understood to imply anything but subjective estimates, guesses and hunches [of price, output and sales]’ (Machlup, 1946, p. 522). It is not with businessmen’s rationalization of their actions but with their actual behaviour that marginal analysis is concerned: ‘The technical terms used in the explanation of an action need not have any part in the thinking of the acting individual’ (Machlup, 1946, p. 537).

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Keynes The pièce de résistance of the Cambridge critique against neoclassical theory is Keynes’s General Theory (1936) where, nevertheless, we find the assumption of rising marginal costs, and the implied inverse relationship between employment and real wage, which are evidences that not all ties with the Marshallian apparatus were severed. However, the passages in the General Theory devoted to the analysis of the equilibrium of a single firm in terms of profit maximization are very few and the same applies to the preparatory work. The most explicit reference is taken from one of the drafts of Chapter 3:9 Each firm calculates the prospective selling price of its output and its variable costs in respect of output on various possible scales of production. Its variable cost per unit is not, as a rule, constant for all volumes of output but increases as output increases. Output is then pushed to the point at which the prospective selling price no longer exceeds the marginal variable cost. (Keynes, 1979, p. 98; see also p. 89) The passage, perhaps significantly, was not included in the final version, but there is no textual evidence in the General Theory which could authorize the reader to think that Keynes substantially changed his mind on this particular matter. On the other hand, it is worth noticing here that there is no a specific part of his widespread scientific production which is explicitly devoted to a comprehensive analysis of this issue: he seems not to have dedicated too much effort and time to go deeper into this aspect of economic theory. In the General Theory the relevant passages are: ‘The entrepreneur’s income [. . .] is taken as being equal to the quantity, depending on his scale of production, which he endeavours to maximise, i.e. to his gross profit in the ordinary sense of this term; – which agrees with common sense’ (Keynes, 1936, pp. 53–54; see also p. 56); and ‘For entrepreneurs will endeavour to fix the amount of employment at the level which they expect to maximise the excess of the proceeds over the factor cost’ (Keynes, 1936, pp. 24–25). It seems evident that Keynes adopted the marginal language and employed it quite sparingly, as if – one is tempted to infer – it were outside the core of his analysis. Reliance on the Marshallian apparatus – demand and supply curves – is, in fact, limited in the General Theory, whose main message is its being other than the ‘classical’ theory. Keynes’s criticism of the latter consisted ‘in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world’ (Keynes, 1936, p. 378).10 We may perhaps infer, a contrario, that the assumptions behind profit maximization appeared to Keynes to be sufficiently explicit and general to make them acceptable. Here we can measure the distance from Sraffa who, in the same years, was starting to attack marginal analysis at its foundations, evidently

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never managing fully to persuade Keynes of the necessity to discard the neoclassical citadel on this ground (see Marcuzzo and Rosselli, 2006).11 On the other hand, Keynes’s path-breaking views mainly concern investment decisions, the determination of its prospective yields, the influence of expectation and uncertainty in economic calculation, and the role of speculative activity. As a consequence, entrepreneurs are seen not to be proceeding on the base of a rational calculus, but as conforming to instincts, conventions and habits (Keynes, 1936, p. 152).12 In the General Theory, indeed, investment decisions, as opposed to the determination of the level of individual output, are never made on ‘a precise calculation of prospective profit’: they are the outcome of a sort of lottery in which [. . .] even after the event no one would know whether the average results in terms of the sums invested had exceeded, equalled or fallen short of the prevailing rate of interest [. . .]. If human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation. (Keynes, 1936, p. 150) Moreover, in Keynes, as noted by Roncaglia (2006), ‘there is a distinction of economic agents and decisions according to the “kind” of uncertainty involved: entrepreneurs have to be kept distinct from financiers, and both from households; among entrepreneur’s decisions, those concerning investments have to be kept separate from those concerning production levels’. In the face of ‘fundamental’ uncertainty, a way out for the entrepreneurs is to follow some conventional rules, as for example ‘to take the existing situation and to project it into the future, modified only to the extent that we have more or less definitive reasons for expecting a change’ (Keynes, 1936, p. 148). Another is to try to guess the prospective yields on the basis of a rational conjecture, taking into account the degree of ignorance on the causes influencing the results, through a proceeding similar to trial and error. Keynes writes in a famous passage of the General Theory: Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. (Keynes, 1936, p. 161)13 This passage seems to us to be clear evidence of his rejection of mathematical calculus to represent what is behind entrepreneurs’ actions, rather than a belief in the ‘irrational’ nature of the entrepreneur’s decision process (see also Keynes, 1936, pp. 162–163). The relevant distinction here is between the set of elements which are taken

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into consideration by individuals to make a decision and the set of elements into which they can be transformed in order to build an economic theory. Unlike the example of the motorcyclist who finds the optimum angle of inclination in making a turn, without any calculation, but as if he had full knowledge of the laws of kinetics, Keynes’s description of entrepreneur behaviour shows that it is misleading to interpret MR  MC as an approximate rule of behaviour, because other elements enter in the decision-making process, which are missed out in translating ‘instinct’ into ‘calculus’.

Kalecki The peculiarity of Kalecki’s approach is that when working with imperfect competition he did not rely on the profit maximization assumption. This was perceived as an anomaly by Joan Robinson, who, in one of her first letters to Kalecki, in relation to his article ‘A Theory of the Business Cycle’ (Kalecki, 1936), which she received in draft form,14 commented: ‘Keynes’s system, as you say, is unrealistic, but yours it is troublesome because marginal prime cost as you define it is not equal to marginal revenue, or is only equal to it if entrepreneurs are very foolish’ (Robinson to Kalecki, 16 September 1936, in Kalecki, 1990, p. 502). In that article Kalecki (1936, pp. 529–534) constructs a marginal labour cost curve (MLC) and a marginal value added curve (MVA), both derived by subtracting respectively from the prime costs curve and the marginal revenue curve (supposed to be decreasing) the cost of raw materials. The curves are first derived for the individual firm and then aggregated for the system as a whole, in the determination of the short-period equilibrium level of output. The position of the marginal labour cost curve is fixed by assumption in the short period, since capital equipment is fixed. But the position of the marginal value added curve depends on the level of the capitalists’ expenditure, on the basis of the wellknown Kaleckian assumption according to which only capitalists save and can change their level of expenditure. Thus, the marginal value added curve moves until the short-period equilibrium is reached. It is not clear whether Robinson is objecting to an equilibrium defined at the point of intersection between the MVA curve and MLC curve, or to a lack of a specific assumption on entrepreneur’s behaviour when choosing the level of the firm’s output. However, she seems to imply that she was not ready to follow Kalecki in his abandonment of the profit maximization rule. The development of Kalecki’s ideas follows his involvement in Sraffa’s seminar15 in Cambridge and his research activity in 1938–39.16 In the Autumn of 1938 the Cambridge Research Scheme of the National Institute of Economic and Social Research into Prime Costs, Proceeds and Output was set up, under the supervision of a committee consisting of Austin Robinson, Kahn, Kalecki and Sraffa, with Keynes as Chairman. At the end of the first year Kalecki presented the principal results of the research in the form of individual reports on the single industries and a general report (for further details see Marcuzzo, 2005).

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In his Interim Summary of Results (Summer, 1939), Kalecki synthesized the nature of that inquiry. The ratio of aggregate proceeds to aggregate prime costs (i.e. raw material bill plus wage bill) and the corresponding indices of the volume of output were calculated for six industries. The ‘degree of monopoly’17 was brought in to explain the variation of prices, together with the relative share of wages in the value of net output and raw materials prices (Kahn papers, King’s College, RFK 5/1/83). These reports came under heavy fire from Keynes, Kahn and Joan Robinson,18 who objected to the methodology employed.19 Soon afterwards Kalecki resigned from the Cambridge post and set himself to ‘writing a theoretical interpretation of the results’ (letter from Kalecki to Kahn, 9 June 1939, in RFK 5/1/147), which he did in his article on the Supply Curve (Kalecki, 1940). In that article he was still retaining some sort of marginal analysis, but he was moving away from it, as it is clearly accomplished in his Studies in Economic Dynamics (Kalecki, 1943). In this work two new assumptions were adopted: a) ‘the average prime cost changes little as output expands’; b) ‘the entrepreneur takes the average prime costs [which usually varies little as output expands] as a crude approximation of the marginal costs. The latter seems to be borne out by recent enquires, which showed that entrepreneurs are really not familiar with the exact concept of marginal cost’ (Kalecki, 1943, p. 119). The relevant point here is that since average costs are assumed to be almost constant, marginal costs are also constant, and thus they lose their importance in determining the level of output. Moreover, average cost is easier to be conceived of and this is why entrepreneurs rely on it rather than on marginal cost. Kalecki, unlike Kahn, is more willing to accept as reliable what entrepreneurs say they are doing, although he was as critical as Kahn was towards Hall and Hitch, as we shall see below. For much of his late 1930s analysis, Kalecki seems to have followed the line of thought which held that, as long as a market is imperfectly competitive – that is, each firm faces a downward-sloping demand curve – marginal cost can be retained as basis for price and output determination. He appears to have moved towards the acceptance of average cost pricing only in the early 1940s. Kalecki’s theory in fact moved in the direction of mark-up pricing20 in a context of oligopoly with the particular hypothesis of a pro-cyclical movement of the elasticity of demand (Kalecki, 1991, p. 496). It is only in the Theory of Economic Dynamics (1954) however, that Kalecki takes an explicit stance against profit maximization: ‘In view of the uncertainties faced in the process of price-fixing, it will not be assumed that the firm attempts to maximize its profits in any precise sort of manner’ (Kalecki, 1954, p. 210). The crucial switch point in the development of Kalecki’s thinking was the adoption of oligopoly rather than static imperfect competition into his framework of analysis. Strategic behaviour involves limited and bounded rationality where the simplicity of profit maximization behaviour is no longer a viable hypothesis. Interestingly enough, Kahn, unlike Kalecki, remained faithful to the profit maximization approach, also in the cases of duopoly and a kinked demand curve. He wrote: ‘[The kinked demand curve] is compatible with the traditional

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hypothesis of profit maximization [. . .] all that the kinked demand curve explains is why the price remains where it is (for no other reason than that it happens to be there) until something happens to cause it to alter’ (Kahn, 1952, p. 122).

Cambridge criticism of ‘full cost’ pricing Reliance on average cost rather than marginal cost in setting prices is indeed what is done in the so called ‘full-cost’ principle and this explains why this approach is favoured in the Post Keynesian tradition. However, criticism of ‘full cost pricing’ – at least in the version of Hall and Hitch (1939) – was put forward both by Kahn and Kalecki, disproving the common belief in a full endorsement of it within the Cambridge tradition. Hall and Hitch presented the results of an inquiry into firms’ behaviour in setting prices, based on a questionnaire submitted to 38 entrepreneurs. The main findings were that entrepreneurs aimed to cover their average costs, to which they added a fixed percentage margin, rather than trying to maximizing their profit by equating marginal revenue to marginal costs (Besomi, 1998). This approach became known as the ‘full cost principle’. The criticisms raised against it by Kahn can be summarized as follows. 1

2

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It has a slender factual basis. After noting that Hall and Hitch’s study was based on only 38 interviews, Kahn examined each of them and concluded that only eight responses, in fact, confirmed the above principle. He then concludes: ‘The one quite certain conclusion to which the Hall–Hitch article drives the reader is that far too elaborate a theoretical edifice has, in the twelve years which have elapsed since its publication, been built on a very slender factual basis’ (Kahn, 1952, p. 121). It is not a general principle for setting prices, but is rather a mechanism to which firms turn when trade is slack and excess capacity occurs: ‘as a selfdefence mechanism, protecting business men against the disastrous effects on profits produced by the existence of surplus capacity in an industry which is fairly competitive and homogeneous’ (Kahn, 1952, p. 123). When the demand is falling, the profit maximization rule (or the loss minimization rule) would require a reduction of the quantity produced, to which corresponds – given increasing marginal costs – a reduction of profit per unit of product, but which guarantees at the same time a minimization of the negative effects due to the fall in demand. If, on the contrary, the prices were kept so as to provide a given mark-up, then the reduction of total profits will be lower. It is a rationalization not a description of actual behaviour. Kahn goes so far as to indicate that it is a false rationalization, because the MC  MR formula is followed by entrepreneurs by ‘instinct rather than reasoning’ (Kahn, 1952, p. 126). There is no real opposition between the full-cost and marginal rules if the latter is more generally interpreted as profit maximization rule, which is attained by repeated attempts: ‘Put in that more homely form, the concept

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does readily lend itself to the operation of the forces of trial and error, and to the display of flair – the success of which by no means depends upon the manner in which it is rationalized’ (Kahn, 1952, p. 127). Kalecki, for his part, raised the following criticisms. First, account has to be taken of the influence of prices of other firms. He wrote: The degree of monopoly may, but need not necessarily increase as a result of a rise in overheads in relation to prime costs. This and the emphasis on the influence of prices of other firms constitute the difference between the theory presented here and the so-called full-cost theory. (Kalecki, 1991, p. 216)21 Second, the mark-up concept has no precise theoretical meaning. Like Kahn, Kalecki was also convinced of the analytical vagueness of the full-cost principle, as it appears in the following quotation: The full cost theory in its familiar version maintains that the firm fixes its price by adding to average prime costs the overheads per unit of actual output or per unit of ‘standard’ output (i.e. per unit of output corresponding to what is considered reasonably full employment of firms’ plant) and ‘something’ for profit. This statement has no precise theoretical meaning, because the amount that is added for profit makes quite a lot of difference to the price and more still to the gross margin. (Kalecki, 1991, p. 134) Third, Kalecki, again like Kahn, thought that what the entrepreneurs say they do is not exactly what they do: The full cost-theory has actually been derived from the replies of entrepreneurs to enquiries about their pricing methods [Hall and Hitch, 1939]. But it is not unlikely that the procedure described by them is not the actual process of fixing prices but only a check applied to prices fixed in another way to see whether they make any net profit. (Kalecki, 1991, p. 134) In conclusion, while Kalecki linked the principle for determining prices based on a mark-up to the macroeconomic context and income distribution, struggling to give to mark-up pricing better theoretical foundations and greater empirical content, Kahn remained faithful to the Marshallian apparatus, although he made path-breaking contributions to the theory of duopoly. As has been noted: Kahn’s research into the cotton and wool industries, and A. Robinson’s involvement with the Cambridge University Press Syndicate, acquaintance with the shipping industry, and general knowledge about real-life firms

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Conclusions Marshall managed to keep in hand both threads of analysis of business behaviour, one based on a short-period static equilibrium of the firm, the other on the evolutionary adaptation to a ‘social’ environment. In the aftermath of Marshall, the field was opened up to different approaches. Kahn championed the ‘marginal principle’ for the determination of price and output for the single firm and was instrumental in persuading Keynes to adopt the marginal approach in the General Theory (Marcuzzo, 2002). His endorsement of the principle was mainly the outcome of his investigation into the ‘Economics of the Short Period’ (Kahn, 1989, 1932a, 1932b) and the result of his collaboration with Joan Robinson between 1930 and 1933, during the writing of her Economics of Imperfect Competition (1933). Keynes never rejected increasing marginal costs in the General Theory and this led him to adopt assumptions, which brought conclusions which were found at variance with facts.22 Kalecki, in his turn, followed a line of research progressively distant from the MC  MR rule, which led him to reject marginal analysis in toto. On the other hand, both Keynes and Kahn dropped the ‘maximizing rule’ when analysing entrepreneurs’ behaviour in financial markets and regarding investment decisions. The existence of uncertainty and various degrees of conviction with which opinions are formed and held by individuals makes the decision process similar not to an optimum solution, but rather to a condition reached when sufficiently strong motives to do otherwise are lacking. No appeal to the marginal principle is deemed necessary here. Notwithstanding Sraffa’s stance against marginalism, the Post Keynesian endorsement of some kind of full-cost pricing – discarding perfect competition and rising marginal costs – and the rejection by Kahn and Keynes of ‘calculus’ in dealing with the uncertainty prevailing in money markets, profit maximization was part and parcel of the approach to pricing taken by Marshall, Kahn and Keynes and, until the late 1940s, also Joan Robinson and Kalecki. This conclusion goes against the Post Keynesian reconstruction of the Cambridge approach to price determination as based on the full-cost principle. On the contrary, our historical investigation has shown that, at least as far as the preSecond World War years were concerned, the Cambridge of the Post Keynesian view is more an ‘invented’ (in the sense of Hobsbawm, 1983) than a true tradition.

Notes * An early draft of this chapter appeared as a working paper, Dipartmento di Scienze Economiche, Università di Roma ‘La Sapienza’. We thank for their comments, criticisms

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and suggestions various people, although we have not always followed their advice: A. Carabelli, M. Dardi, N. De Vecchi, C. Panico, T. Raffaelli, A. Roncaglia, N. Salvadori, L. Zamparelli. We are also grateful to G. Mongiovi for his careful editing, and to P. Garegnani for permission to quote from an unpublished work of P. Sraffa. It should be borne in mind that a difference exists between price theory, which explains how the equilibrium price is determined, and pricing policy, which explains how entrepreneurs react to cost changes. The former is relevant to understand how the entrepreneurs behave in the position of equilibrium; the latter is relevant to describe their behaviour outside equilibrium. Our analysis is confined here to the role of profit maximization in price theory rather than in the pricing mechanism (in the above sense of a rule of cost-adjustment), which may have behind it, in principle, different price theories. We are indebted to Alessandro Roncaglia for this distinction. Throughout this chapter by profit maximization we invariably mean the equalization of marginal cost to marginal revenue, as it shows itself in the marginalist (neoclassical) approach. Robertson (1930) first stressed the biological analogy in Marshall’s representation of the firm. On the Marshallian conception of the firm as distinct from the neoclassical one see, e.g., Loasby (1990, 1999); on the influences of Smith’s and Mill’s analyses of the entrepreneurship on Marshall see Pesciarelli (1989) and Caldari (2001). The Italian translation is in Kahn (1999). The ‘trial and error’ metaphor in describing businessmen behaviour was defined as ‘benign marginalism’ by Mongin (1991). See the interviews with entrepreneurs in cotton and coal industries in Kahn’s Dissertation and in Hall and Hitch (1939). It may seem here that some other arguments enter into the expected benefits function by the entrepreneur without entering into the maximization process. We thank Carlo Panico for this remark. The chapter was entitled ‘The Characteristics of an Entrepreneur Economy’ (from the December 1933 table of contents; see Keynes, 1973, p. 421). On Keynes’s criticism of neoclassical theory see Carabelli and De Vecchi (1999). The following passage of 1929, from Sraffa’s unpublished writings, would hardly have been endorsed by Keynes: ‘[. . .] [demand and supply curves, marginal productivities, which form the basis of Marshall’s theory, (or, rather, Pareto’s)] do not exist at any one moment, nor during any period of the recurrent steady process of production and consumption’ (Sraffa Papers, D3/12/13). In other words Sraffa, unlike Keynes, was objecting to the entire theory of value and distribution associated to neoclassical analysis, while Keynes was concerned with pointing out those ‘logical flaws’ of the ‘Classics’ which had to do with its supposed ‘generality’. According to Raffaelli (2003, p. 138): Both [Marshall and Keynes] rejected the economic man and indeed when Keynes baldly stated that in many a situation ‘we fall back [. . .] on motives [. . .] which are not “rational” in the sense of being concerned with the evaluation of consequences, but are decided by habit, instincts, preference, desire, will etc’ [. . .] he was reviving and radicalizing Marshall’s lesson. Where they parted company was in the meaning they attached to such words as habit and custom. Keynes [unlike Marshall] played down the ability of habit and custom to grow and improve [. . .] thanks of the imprimatur conferred on them by evolution.

13 On Keynes’s concept of ‘logical probability’ see Carabelli (1988). 14 According to Kalecki’s editor, J. Osiatynski, this was the article in question (Kalecki, 1990, p. 501). 15 It was the ‘Cambridge Graduate Seminar’, chaired by Sraffa and devoted to research students (see Marcuzzo and Sanfilippo, 2007).

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16 According to Sawyer (2001, p. 253): ‘[. . .] it is only in the second half of the 1930s [that] the associated assumptions of non-increasing average costs (up to capacity) and imperfect competition became a central feature of Kalecki’s analysis.’ 17 The concept was originally introduced by Lerner (1934) and it was defined as the ratio of the difference between price and marginal cost to price. Under perfect competition the degree of monopoly is obviously zero. 18 It was much later, possibly under the influence of her appreciation of Sraffa’s rehabilitation of classical political economy, that she changed her mind, defending Kalecki’s ‘degree of monopoly’ (Robinson, 1979). 19 The concept of ‘degree of monopoly’ was particularly attacked. Keynes renewed his criticism when he accepted Kalecki’s rejoinder to Whitman, who had also criticized the degree of monopoly concept, for the Economic Journal: ‘The difficulty is, I think, that the phrase “degree of monopoly” does not easily convey to the intuition of the reader the precise analytical meaning which your strict definition attaches to it’ (Keynes to Kalecki, 29 October 1941, in Kalecki, 1991, p. 492). 20 For a reading of Kalecki’s price theory in the sense of continuity see Basile and Salvadori (1984–85, 1991). 21 According to Osiatynski (in Kalecki, 1991, p. 496), Kalecki in his 1943 article points out that ‘the difference between the “full-cost” theory and his own approach [lies in the fact that while] in the former every change in the average prime costs automatically passed on to the price, [. . .] [in the latter] the price also depends on the prices set by other manufacturers’. For a criticism of Kalecki’s rejection of full-cost theory, see Lee (1985). 22 For instance, the increasing marginal cost assumption made him conclude that real and money wages varied in the opposite direction in the cycle. The empirical findings of Dunlop, Tarshis and Kalecki, which disproved his conclusion and with it the inference of an inverse relation between employment and real wage, made him to recant in 1939 (Marcuzzo, 1993).

References Basile, L. and Salvadori, N. (1984–85) ‘Kalecki’s Pricing Theory’, Journal of PostKeynesian Economics, 7, pp. 249–262. Basile, L. and Salvadori, N. (1991) ‘Kalecki’s Pricing Theory Revisited’, Journal of Post-Keynesian Economics, 14, pp. 293–297. Becattini, G. (1962) Il Concetto di Industria e la Teoria Del Valore (Torino: Boringhieri). Besomi, D. (1998) ‘Roy Harrod and the Oxford Economists’ Research Group’s inquiry on prices and interest 1936–39’, Oxford Economic Papers, 50, pp. 534–562. Caldari, K. (2001) ‘L’Uno e il Molteplice nel pensiero economico di Alfred Marshall. Una rilettura di alcuni temi centrali del pensiero marshalliano, alla luce di scritti editi ed inediti’, Tesi di dottorato, Biblioteca Nazionale di Roma e Firenze. Carabelli, A. (1988) On Keynes’s Method (London: Macmillan). Carabelli, A. and De Vecchi, N. (1999) ‘ “Where to Draw the Line”? Hayek and Keynes on Knowledge, Ethics and Economics’, European Journal of the History of Economic Thought, 6, pp. 271–296. Dardi, M. (2003) ‘Alfred Marshall’s Partial Equilibrium: Dynamics in Disguise’, in R. Arena and M. Quére (eds) The Economics of Alfred Marshall (Basingstoke: Palgrave). Hall, R.L. and Hitch, C.J. (1939) ‘Price Theory and Business Behaviour’, Oxford Economic Papers, 2, pp. 12–45. Hobsbawm, E. (1983) ‘Introduction: Inventing Tradition’, in E. Hobsbawm and T. Ranger (eds) The Invention of Tradition (Cambridge: Cambridge University Press).

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Kahn, R.F. (1932a) The Economics of the Short Period, unpublished manuscript, in Kahn papers, King’s College, Cambridge. Kahn, R.F. (1932b) ‘Imperfect Competition and the Marginal Principle’, unpublished article, in Kahn papers, King’s College, Cambridge. Kahn, R.F. (1952) ‘Oxford Studies in Price Mechanism’, Economic Journal, 62, pp. 119–130. Kahn, R.F. (1989) The Economics of the Short Period (London: Macmillan). Kahn, R.F. (1999) Concorrenza, occupazione e moneta (Bologna: Il Mulino). Kalecki, M. (1936) ‘A Theory of the Business Cycle’, in Collected Works of Michal Kalecki. Vol. I: Capitalism. Business Cycles and Full Employment, ed. J. Osiatynski (Oxford: Clarendon Press, 1991). Kalecki, M. (1940) ‘The Supply Curve of an Industry under Imperfect Competition’, Review of Economic Studies, 7, pp. 91–112. Kalecki, M. (1943) Studies in Economic Dynamics, in Collected Works of Michal Kalecki. Vol. II: Capitalism. Economic Dynamics, ed. J. Osiatynski (Oxford: Clarendon Press, 1991). Kalecki, M. (1954) Theory of Economic Dynamics, in Collected Works of Michal Kalecki. Vol. II: Capitalism. Economic Dynamics, ed. J. Osiatynski (Oxford: Clarendon Press, 1990). Kalecki, M. (1990) Collected Works of Michal Kalecki. Vol. I: Capitalism. Business Cycles and Full Employment, ed. J. Osiatynski (Oxford: Clarendon Press). Kalecki, M. (1991) Collected Works of Michal Kalecki. Vol. II: Capitalism. Economic Dynamics, ed. J. Osiatynski (Oxford: Clarendon Press). Keynes, J.M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). Keynes, J.M. (1973) The General Theory and After: Part I. Preparation, in The Collected Writings of John Maynard Keynes, Vol. XIII, ed. D. Moggridge (London: Macmillan). Keynes, J.M. (1979) The General Theory and After. A Supplement, in The Collected Writings of John Maynard Keynes, Vol. XXIX, ed. D. Moggridge (London: Macmillan). Lee, F.S. (1985) ‘Kalecki’s Pricing Theory: Two Comments’, Journal of Post-Keynesian Economics, 8, pp. 145–148. Lee, F.S. and Irving-Lessman, J. (1992) ‘The Fate of an Errant Hypothesis: the Doctrine of Normal-Cost Prices’, History of Political Economy, 24, pp. 273–309. Lerner, A.P. (1934) ‘The Concept of Monopoly and the Measurement of Monopoly Power’, Review of Economic Studies, 1, pp. 157–175. Loasby, B.J. (1990) ‘Firms, Markets and the Principle of Continuity’, in J.K. Whitaker (ed.) Centenary Essays on Alfred Marshall (Cambridge: Cambridge University Press). Loasby, B.J. (1999) ‘Marshall’s Theory of the Firm’, in R.E. Backhouse and J. Creedy (eds) From Classical Economics to the Theory of the Firm: Essays in Honour of D.P. O’Brien (Cheltenham: Edward Elgar). Machlup, F.A. (1946) ‘Marginal Analysis and Empirical Research’, American Economic Review, 36, pp. 519–554. Marcuzzo, M.C. (1993) ‘La relazione salari-occupazione tra rigidità reali e rigidità nominali’, Economia Politica, 10, pp. 439–463. Marcuzzo, M.C. (2002) ‘The Collaboration between J.M. Keynes and R.F. Kahn from the Treatise to the General Theory’, History of Political Economy, 34, pp. 421–447. Marcuzzo, M.C. (2003) ‘Joan Robinson and the Three Cambridge Revolutions’, Review of Political Economy, 15, pp. 545–560.

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Marcuzzo, M.C. (2005) ‘Piero Sraffa at the University of Cambridge’, European Journal of History of Economic Thought, 12, pp. 425–452. Marcuzzo, M.C. and Rosselli, A. (2006) ‘Sraffa and His Reasons against “Marginism” ’, in M.C. Marcuzzo (ed.) The Cambridge Approach to Economics: A Re-invented Tradition?, Roma: Dipartimento di Scienze Economiche, Università di Roma ‘La Sapienza’. Marcuzzo, M.C. and Sanfilippo, E. (2007) ‘Dear John, Dear Ursula, (Cambridge and LSE, 1935): 88 letters unearthed’, in R. Scazzieri, A.K. Sen and S. Zamagni (eds) Markets, Money and Capital: Hicksian Economics for the 21st Century (Cambridge: Cambridge University Press). Marshall, A. (1919) Industry and Trade (London: Macmillan). Marshall, A. (1920) Principles of Economics, 9th (Variorum) edn, ed. C.W. Guillebaud, 2 vols (London: Macmillan). Mongin, P. (1991) ‘The early full-cost debate and the problem of empirically testing profit maximization’, Journal of Post Keynesian Economics, 2, pp. 236–251. Pesciarelli, E. (1989) ‘Smith, Bentham and the Development of Contrasting Ideas on Entrepreneurship’, History of Political Economy, 3, pp. 521–536. Pesciarelli, E. (1991) ‘The Undertaker’s Role in Marshall’s Approach to Economic Growth’, Quaderni di Storia dell’Economia Politica, 2–3, pp. 133–158. Raffaelli, T. (2003) Marshall’s Evolutionary Economics (London: Routledge). Raffaelli, T. (2004) ‘Whatever Happened to Marshall’s Industrial Economics’, European Journal of History of Economic Thought, 11, pp. 209–229. Robertson, D.H. (1930) ‘The Trees of the Forest’, Economic Journal, 40, pp. 80–89. Robinson, J. (1933) The Economics of Imperfect Competition (London: Macmillan). Robinson, J. (1979) ‘Michael Kalecki’, Collected Economic Papers, vol. V (Oxford: Blackwell). Roncaglia, A. (2006) ‘Keynes and Probability: An Assessment’, in M.C. Marcuzzo (ed.) The Cambridge Approach to Economics: A Re-invented Tradition? (Roma: Dipartimento di Scienze Economiche, Università di Roma ‘La Sapienza’). Sawyer, M. (2001) ‘Review Article. Kalecki on Imperfect Competition, Inflation and Money’, Cambridge Journal of Economics, 2, pp. 245–261. Sraffa, P. (1925) ‘Sulle Relazioni fra Costo e Quantità Prodotta’, Annali di Economia, 2, pp. 277–328. Sraffa, P. (1926) ‘The Laws of Returns under Competitive Conditions’, Economic Journal, 36, pp. 535–550.

Part II

Post Keynesian macroeconomics

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What is Post Keynesian economics? Richard P.F. Holt

Introduction Many of us are familiar with the letter that John Maynard Keynes sent to George Bernard Shaw on New Year’s Day 1935 where he said that he believed himself to be writing a book that “will largely revolutionize . . . the way the world thinks about economic problems” (Keynes, 1971, p. 492). Since we recently celebrated the 70th anniversary of Keynes’s General Theory, it is fitting to evaluate where the Keynesian revolution stands today. Sadly, things don’t look very good: the Keynesian revolution has been attacked, ignored, and distorted by both mainstream and heterodox economists. Most economists think the Keynesian revolution was led by Paul Samuelson, Robert Solow, James Tobin, James Meade, and John Hicks, figures more concerned with preserving general equilibrium analysis than with understanding Keynes. In the 1950s and 1960s Keynesian macroeconomics looked like a cook book where you change taxes here, change the money supply there, and presto – with lightning speed, logic takes us back to full employment. But then we encountered stagflation in the 1970s. Although stagflation could be explained by Keynesian macroeconomic models, a younger generation of economists arose that did not experience the Great Depression or the New Deal, and who found career opportunities in the 1980s coasting on the conservative wave called “New Classical Economics.” Because neoclassical Keynesians never abandoned classical theory, they made it easy for this new generation of economists to go back to classical theory. Neoclassical Keynesians never questioned long-run equilibrium; they assumed the economy has a central tendency, Say’s Law prevails, and that money is neutral. Solow’s growth model exemplifies this very well. In this model, an economy grows through logical time, with techniques of production chosen by market forces that also determine the marginal productivity conditions, which, in turn, determine the distribution of income. The model fails to discuss historical or structural changes, there is no role for money, and while there is some discussion of the role of demand, it is limited to the short run; all the action is on the supply side, with production function shifts caused by technological changes that are just given.

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In attempting to counter New Classical Economics, the New Keynesians got their “Keynes” by looking at the short run, where they saw problems of asymmetric information, limited rationality, price stickiness, and other market imperfections. If these imperfections could be eliminated, then all would be right and the economy would find itself back at general equilibrium. But unless one is willing to reject general equilibrium analysis based on Say’s Law, the essence of Keynes’s revolution is lost; and it has been lost by the economic profession. The following quote pretty much represents where the majority of the economics profession stands today with regard to Keynes: “General Theory is an obscure book. . . . We are in a much better position than Keynes was to figure out how the economy works. . . . Classical economics is right in the long run. Moreover, economists today are more interested in the long-run equilibrium” (Mankiw, 1992, pp. 560–61). The Keynesian revolution hasn’t been helped by heterodox economists either, even by those who claim to be Post Keynesians, where you would expect at least some adherence to the “Keynesian” part of Post Keynesian economics. Recent surveys of Post Keynesian economics give the impression that authors want to separate themselves from Keynes rather than connecting with him. This is true despite the fact that there are still those who claim that “Post-Keynesian economics is based on Keynes’s ideas with the clear intent to extend them to their logical full development” (Arestis, 1992, p. ix). There is some effort among Post Keynesians to extend Keynes’s ideas (Dunn, 2000), but this too is limited. Part of the problem is that Post Keynesians have come to rely on what has been called the “Babylonian tradition” or an “open systems approach,” which seems to say that almost any methodological approach you want to use is fine. One virtue of this tack is an appreciation for pluralism (Dow 1996, 1997, 2001); its negative consequence is that a single coherent paradigm might not be obtainable. This presents us with a disagreeable tradeoff, and puts Post Keynesians in a difficult situation: In some circumstances, it may be found appropriate to assume that individuals are well informed about the future, whereas on other occasions stress may be placed on the uncertainty of the future (and different views can be taken on the extent of such uncertainty and how individuals respond to uncertainty). It also means that conflicting modes of analysis co-exist under the general heading of post Keynesian economics. Some find equilibrium analysis of assistance, whilst others argue that such analysis is of little use; some find formal mathematical modeling of use whilst others would reject such modeling. The multi-paradigmatic nature of post Keynesian economics can lead to intense conflict between the adherents of different paradigms. . . . Any emergence of a single encompassing and coherent post Keynesian paradigm would appear to be a long way off. (Sawyer, 1995, p. 51) Another part of the problem is that there are Post Keynesians who argue that a coherent methodology or new paradigm is possible, but that it can only be

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achieved by a synthesis of “various streams of post-classical economics,” which they admit could circumvent much of Keynes’s message: “This, after all, may be the appropriate definition of what post-Keynesianism is. Such a position may, however, require relinquishing the most extreme views [of Keynes] which cannot be entertained within the synthesis, however fundamental these views seem to be from the point of view of their proponents” (Lavoie, 1992, p. 3). More extreme is the following comment by Dostaler (1988, p. 134): “Kalecki can be considered the real founder of post-Keynesian theory.” These authors see the Keynesian revolution as limited, and think that for a new paradigm to emerge Post Keynesians must go beyond Keynes and incorporate the insights of Marx, Sraffa, Kalecki and the Cambridge economists of the 1940s and 1950s. Two main problems they see with Keynes are that he has no long-run analysis and that his price theory seems too neoclassical. The irony of this attempt to form a synthesis between “various streams of post-classical economics” is that instead of achieving a coherent general framework or a new paradigm, it has led Post Keynesian thought to the Babylonian tradition or a “horses for courses” approach (Harcourt 1999), where developing a coherent Post Keynesian paradigm would appear to be a long way off. My point here is not to argue that Post Keynesians should not use the Babylonian approach, but to point out the consequences of this methodology – it takes us away from Keynes’s revolution and mires Post Keynesian economics in methodological debates. Another consequence of this is that mainstream economics does not take Post Keynesians seriously. Jan Kregel (1973) points out that many in the economics profession look at Post Keynesian economics as a nuisance, providing negative comments and critiques but having nothing to say about the hard questions or providing a serious alternative theory to neoclassical theory. Given the Babylonian approach that Post Keynesians follow today, one can see why many in the mainstream have this view and why they are confused about Post Keynesian economics. This is unfortunate because Post Keynesians have a powerful message to present. It is a message that is badly needed today, and a message that can be traced back to 1936 with Keynes’s hope of providing an “economic theory which will revolutionize . . . the way the world thinks about economic problems.” To bring back this revolution it is important for Post Keynesians to develop some solidarity and to understand what we are fighting for. To do this requires some common ground.

Fundamental features of Post Keynesian economics This section sets out in very general terms what I consider to be the four fundamental features of Post Keynesian economics. By defining these features generally, I hope that Post Keynesians will be able to agree on them, and to see their logical consequences and their importance. The next section sets forth some concerns with the Babylonian approach. The final section looks ahead by discussing how Post Keynesians might want to think about contemporary issues, using globalization as an example.

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The real world The first feature that I hope we can all agree on is that the primary goal of Post Keynesian economics is to understand the nature of the capitalist system and to develop a practical ability to deal with real world economic problems. Such a position has been stated clearly and consistently by such diverse Post Keynesians as Vicky Chick, Paul Davidson, Al Eichner, John Kenneth Galbraith, Hy Minsky, Ed Nell, Ingrid Rima, Joan Robinson, and Sidney Weintraub. Their objective has always been to develop a model that helps us understand how economic processes operate in the real world. To see how revolutionary this objective is, let us compare the definition of “neoclassical economics” with the definition of “Post Keynesian” economics from The MIT Dictionary of Modern Economics. First, the neoclassical definition: Economists have traditionally adopted two approaches in analysing economic systems. The simpler approach associated with the name of A. Marshall, has been that of partial equilibrium, where only a part of the system is examined (e.g. the market of oranges), on the assumption of unchanged conditions in the rest of the economy. The second and more difficult approach, both in conception and in its use of mathematical tools, is general equilibrium analysis, which looks at an economic system as a whole and observes the simultaneous determination of all prices and quantities of all goods and services in the economic system. (Pearce, 1989, p. 167) Now compare this with the definition of “Post Keynesian economics” from the same dictionary, and also with Davidson’s discussion of economic analysis: [Post Keynesians] . . . stress the dynamic nature of an economy which uses money and which is subject to uncertainty. The nature of time is such that markets do not always clear. Individuals in those markets do not always receive the correct signals to encourage optimal behaviour. Post Keynesian economists emphasize the institutional setting of the economy and the social relationships therein. (Pearce, 1989, p. 333) Economic decisions taken in the present will require actions which cannot be completed until some future day (or days). In such a world, economic decision makers are continuously involved in sequential decisions and actions which are colored not only by their expectations of the unknowable future but also by the inherited stocks (which embody correct previous guesses as well as past errors) which they possess. Consequently decisions rarely if ever are made on a clean slate. Thus Post Keynesians will emphasize the role of heterogeneous expectations and the importance of non-fully anticipated events. (Davidson, 1982, p. 9)

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Which sounds richer, less abstract, and more concerned with the real world? This is not to deny that theoretical models, by their nature, abstract from the real world; but the question is which axioms or assumptions you bring into your model. It is on this point that Post Keynesians and neoclassical economists differ significantly.1 Post Keynesians recognize that the world is messy and uncertain, and that economic analysis should try to understand that messiness and uncertainty, instead of developing models that tell us how things “should” be given certain conditions. It is important to remember that Post Keynesian analysis can be traced back to Keynes, and his efforts to understand the real world and develop a general theory of how the capitalist system functioned during his time.2 If we agree that Post Keynesian economics is concerned with understanding how economic processes function in the real world, we can move on to the other key features of Post Keynesians models, those that help us to understand the real world. Three essential features of Post Keynesian economics are the importance of historical time; recognizing that the future is uncertain and that expectations impact economic events; and seeing that institutions and political forces are important in shaping economic events. There is interdependence among these features, and understanding this interdependence is important for understanding Post Keynesian economics. Historical time Of all the features of Post Keynesian economics, this in my mind is the most important. Historical time implies a commitment to understand how economic processes function in the real world. From here we can understand the importance of other Post Keynesian features like uncertainty, money, and the role of institutions. While Post Keynesians share with other schools (e.g., Austrians, Marxists, and Institutionalists) a focus on historical time (compared to mainstream neo-Walrasian theory, where history is a single event), in none of the other schools does historical time play the pivotal role that it does for the Post Keynesians. Also, Post Keynesians have a very clear definition of what historical time is and the role it plays in economic theory. Historical time can be defined as events occurring in a unidirectional sequence. That is, present events need to be defined in the context of what has gone on before, or its history; and so the sequence leading up to the present event matters a great deal. A present event has traces of its past that cannot be removed. This means that the future outcome of an event cannot be predestined, for this would make the past history of the event totally irrelevant. If history does matter, then the future of an event cannot be based on theories of perfect foresight as in rational expectations models (Holt and Setterfield, 1999). Historical time is a major feature of Post Keynesian economics, and one of the major differences between Post Keynesian economics and mainstream general equilibrium analysis. The Arrow–Debreu–MacKenzie neo-Walrasian model is a system of simultaneous equations where the past, present, and future are determined

94 R.P.F. Holt simultaneously. Besides everything happening at once, the system can change with no trace of the processes it goes through to get from one equilibrium point to another. The movement from one point to another is irrelevant; but in the real world, economic processes and decisions do not work this way. As Marc Lavoie (1992, p. 42) points out: “There is no effort in putting forward hypotheses that are realistic. Axioms are chosen, not for their likelihood, but for their ability to allow the existence of equilibrium or its uniqueness. Neo-Walrasians describe the world as it should be rather than as it is.” Although mainstream economics considers itself a science, concerned with understanding the real world through hypothesis testing, it is very careful about which hypotheses it chooses to test. The main hypotheses of neo-Walrasian economics are never questioned, but simply accepted as being true. The science part comes in with “auxiliary hypotheses,” supposedly about the real world, that can be tested (Lavoie, 1992, p. 42). In contrast, historical models define all important causal relations and other aspects of the real world, and then seek to test them: “In a historical model, causal relations have to be specified. Today is a break in time between an unknown future and an irrevocable past. What happens next will result from the interactions of the behavior of human beings within the economy. Movement can only be forward” (Robinson, 1962, p. 26). Finally, we have Keynes who was very much aware of the irreversibility of time and the importance of historical time in economic analysis: During the lengthy process of production the business world is incurring outgoings in terms of money – paying out in money for wages and other expenses of production – in the expectation of recouping this outlay by disposing of the product for money at a later date. (Keynes 1973, p. 33) The state of long-term expectations, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast – on how highly we rate the likelihood of our best forecast turning out quite wrong. (Keynes, 1973, p. 148) These last two quotes are important, for Keynes has been often criticized (by the mainstream and even by many Post Keynesians) for simply providing a short-run theory of aggregate demand and using the traditional techniques of classical economics like Marshallian comparative-static analysis. It is true that, in the very short run, Keynes believed that all expectations could be fulfilled and that traditional equilibrium analysis could be used. But this isn’t what made his work revolutionary. It was his views about “the lengthy process of production” and the “state of long-term expectations” with its range of issues like uncertainty, investment, expectations, the role of money, and shifting from equilibrium to historical and causal models for long-run analysis that makes it unique.

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One of the ironies of all of this is that the neo-Ricardians and the Kaleckians supposedly came to the rescue and provided Post Keynesian economics with a long-run analysis. But the long-run models of these post-classical economists, like their neoclassical counterparts, are wedded to some notion of equilibrium with gravitational deterministic “laws,” while Keynes in his analysis of the “lengthy process of production” brought in uncertainty, money and credit, investment, the role of political and economic institutions, and history in general, into long-run analysis. This is what makes his work so revolutionary – not his short-run views, but his insights into the nature of the long run in an advanced capitalist society. Accepting the view (held by some Post Keynesians) that we need a synthesis of Keynes’s effective demand in the short run and neo-Ricardian “central tendencies of the long period” simply concedes to the mainstream that equilibrium analysis is all that you need. But the world is messy and the future uncertain; as a result, this concession gives up a lot, particularly when one is trying to understand the nature of capitalism with its many institutions that are constantly changing or, using Nell’s (1988) terminology, “transforming.”3 The importance of historical time in model building, particularly for the long run, is one of the key features of Post Keynesian economics. It is consistent with the feature we mentioned earlier (understanding how economic processes function in the real world), and it has several ramifications. The future is uncertain The third feature that I hope Post Keynesians can all agree on follows logically from the second feature. If one accepts that economic processes go through historical time, we must accept that the future is uncertain and the past is immutable. The future has a critical role to play in influencing the present because expectations about the future impact economic events. Because the economy is a historical process heading to an uncertain future, expectations must play an important role in economic events. Given a concern for understanding a production economy governed by markets, and how such an economy develops over time, we need to consider how different economic participants act. For neoclassical economics, the answer can be found by examining the behavior and the “rational” choices made by consumers and firms in their quest to maximize utility and profits, respectively, in a world of constraints. Let us again turn to The MIT Dictionary of Modern Economics to see how the mainstream defines the role expectations for economic agents: [Expectations are] the principle of rational maximizing behavior to the acquisition and processing of information for the purpose of forming a view about the future. It suggests that individuals do not make systematic forecasting errors; on the contrary that their guesses about the future are on average correct. Thus the theory suggests that individuals use all the

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R.P.F. Holt available and relevant information when taking a view about the future and at minimum use information up to the point at which the marginal costs of acquiring and processing information equal the marginal benefits derived from this activity. In the case where information is complete and there is no uncertainty this hypothesis reduces to one of perfect foresight. (Pearce, 1989, p. 360)

Now let us examine Davidson’s (1982, p. 90) definition of an ergodic system where expectations are met, which fits in quite nicely with the previous quote: In an ergodic environment, knowledge about the future involves the projecting of calculated averages based on the past and/or current cross section and/or time-series data to forthcoming events. The future is merely the statistical reflection of the past. Economic activities are timeless and immutable. There can be no ignorance of upcoming events from those who believe the past provides reliable statistical information (price signals) regarding the future, and this knowledge can be obtained if one is willing to spend the resources to examine the existing evidence regarding past patterns. The main consequence of the mainstream view is stated by Lucas (1981, p. 224): “In cases of uncertainty, economic reasoning would be of no value.” This statement is significant because it shows the mainstream cannot allow a serious discussion of uncertainty. It is absolutely essential for the neoclassical notion of equilibrium that expectations are fulfilled. If economic decisions are made, and they turn out to be incorrect, equilibrium is not achieved. The mainstream can only analyze the economy in an ergodic world. Fundamental uncertainty is a key feature of Post Keynesian economics and represents one of its striking differences with mainstream economics. Keynes insisted that the future is uncertain and cannot be reduced to probabilities: The calculus of probability . . . was supposed to be capable of reducing uncertainty to the same calculable status as that of certainty itself. . . . This false rationalisation follows the lines of the Benthamite calculus. The hypothesis of a calculable future leads to a wrong interpretation of the principles of behavior which the need for action compels us to adopt. (Keynes, 1973, pp. xiv, 112, 122) By uncertain knowledge . . . I do not mean merely to distinguish what is known for certain from what is only probable. . . . About these matters there is no scientific basis to form any calculable probability whatever. We simply do not know. (Keynes, 1973, pp. 113–14) Keynes believed that fundamental uncertainty is a crucial element in

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advanced capitalist economies, and that under most circumstances, even if probabilities could be estimated, they were meaningless for long-period decision making. The nature and power of market forces cannot deal with the unpredictability of the long run, and relying on them to do so will lead to incomplete information. Given a commitment to understanding how economic participants act in the real world, Post Keynesians look at the decision-making process in a world of uncertainty. This has led to some interesting work by Post Keynesians on bounded rationality and procedural rationality (Lavoie, 1992, pp. 42–93). In these models, when faced with uncertainty or the inability to process large quantities of complex information, economic agents form rules to follow in their everyday behavior.4 Institutions Our last feature is the importance of institutions. Institutions function at two different levels in Post Keynesian economics. First, Post Keynesians look at the general development and institutional structure of capitalism over a variety of times and societies. The work of Nell on transformational growth, which looks at institutions, technology, and social and political forces, to understand the development of capitalism, represents this level very well: Transformational growth is the study of how the processes and problems generated by the normal operation of the market, when production is organized according to one dominant format, lead to technological innovations which transform that format into another, thus changing the structure of human costs and leading, therefore, to a new and different pattern of normal business responses, and so to a new pattern of adjustment. (Nell, 1994, p. 113) Second, Post Keynesians look at the role of institutions in the economy during a particular era. Davidson (1982, pp. 14–15) explains how economic and political institutions affect the economic system: In the logical world of general equilibrium there are no significant real world economic institutions – not even commodity or financial markets. (This is true despite lengthy neoclassical discussions of market forces.) In a post Keynesian world, on the other hand, economic and political institutions are influential and prominent in determining output, employment and the money price level. These institutions include (a) the banking and monetary systems, (b) time-oriented markets for goods, factors of production, and financial assets, (c) the institution of money contracts for spot and forward transactions, and especially (d) the money wage contract as a necessary condition for liquidity over time for a market-oriented, monetary, entrepreneurial production economy.

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Of course, these two different levels interact with one another. The first gives us a sense of the role that institutions play in forming and transforming economic systems. The second looks at the nature and role of institutions during a specific era. A good example of how both levels interact can be seen in the work of John Kenneth Galbraith. In books such as A Journal through Economic Time (1994) and The New Industrial State (1985), Galbraith explains “how the economy in its larger manifestations has worked” (Galbraith, 1994, p. xiii), but then describes the particular consequences of that manifestation in the current economic and political situation. This is another area in which neoclassical economics limits analysis. The mainstream has continuously fought efforts by such economists as Galbraith and Gunnar Myrdal to broaden the scope of economics by including power and the influence of social and political institutions in its analysis. The mainstream has ignored this area, but Post Keynesians have not; it gives them insights for dealing with the uncertainties of an ever changing economic system moving through time. It also gives them a realistic view of the influence that institutions have on the behavior of individuals and firms. As Malcolm Sawyer’s (1995) work on industrial economics shows, firms are influenced by the institutional settings they find themselves in. This affects firm size, price markups, and market structures.5 We also need to recognize the importance that institutions play for the Post Keynesians in the long run. Given the precarious nature of the future, Keynes recognized that long-term development required institutional arrangements that include public servants trained in policy issues. Anti-inflation policies like TIP, policies to control foreign currency speculation, and banking policies to guarantee the security of deposits all require competent administration; otherwise, they will not achieve their desired end. Thus, an important part of Post Keynesian economics recognizes that we need to develop competent public servants. Buchanan and Wagner (1978) and other public-choice theorists have argued that policy-makers and politicians are just rational human beings, who will act to maximize their own self-interest and will push for policies that reflect those interests; but these policies will not be in the overall interest of society. This position downplays the role of democracy, where you have competing forces, transparency, and an open press. A democratic system will hopefully put into place checks and balances, and allow for open discussion of different policies. But going beyond the political argument, if Keynes is right that we live in a world of uncertainty, then the rational expectations of those pursuing their own self-interest may not be fulfilled (Pressman, 2001, p. 108). Furthermore, Keynes believed that public officials are motivated not just by their own financial selfinterest, but also their reputation, and institutional awards and prestige (Pressman, 2001, p. 108). The policy-making concern for Keynes was not that individuals would act in their narrow self-interest, but that policy-makers possess the right knowledge and theory so that they could carry out public policy for the public good. This is where neoclassical economics has failed the public with its rational expectations models. Instead of recognizing that the

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world is uncertain, and that people usually follow principles of behavior other than economic rationality, mainstream economics has limited the scope of public policy to narrow economic intervention based on unrealistic assumptions. This usually leads to failure, which then gets blamed on political self-interest or incompetent policy-makers. But this position avoids the main issue – because of uncertainty there are macroeconomic failures which require government policies that affect the behavioral habits of economic agents to the benefit of society at large. I do recognize that the four different features given here are put in very general terms and that there are many complications surrounding these issues; but they do represent the essence of Post Keynesian economics and the foundation of Keynes’s revolution. Although those adhering to a Babylonian approach won’t necessarily disagree with these features, their methodological approach not only fails to create a unified paradigm for Post Keynesians, it actually creates the inconsistency and tensions that we see in the current debates among Post Keynesians.

Post Keynesian methodology Sheila Dow (2001, p. 12), an advocate of the Babylonian approach, states that “Early methodological statements of Post Keynesianism emphasized the importance of historical time, and the theoretical implications of taking historical time seriously” and “thought it crucial that there be some correspondence between a theory and the real world.” What is important here is her emphasis that these are early methodological statements. She then goes on to say: “The general methodological approach is an open system approach . . . there is no single set of axioms from which all theories are drawn . . . methodology is still evolving. . . . Debate on these foundations therefore continues” (Dow, 2001, pp. 16–17). This last comment indicates that the Post Keynesian approach is always accepting, and is willing to debate theoretical assumptions. For this reason, it has no set of stable axioms to draw from. But, as mentioned earlier, this approach can lead to a variety of views about Post Keynesian economics and lead to positions that contradict the four core features of Keynes’s revolution. When there are conflicts, the Babylonian approach looks for “intermediate” positions on issues like the use of econometrics or expectations (Mearman, 1998; Laramie, Mair and Miller, 2006). But this just gets us into long debates about the intermediate position. And how can you have an intermediate position on something as fundamental as the use of historical time, or whether the future is uncertain or predictable? An open-system approach, where everything is accepted and debated, inevitably leads to contradictions and inconsistency. This, in turn, leads to more fighting over how Post Keynesians should look at and deal with economic issues. It also leads Post Keynesians to a professional position of simply being gadflies, without offering an alternative explanation of how the economy functions.

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In response to this criticism, Dow (2001, p. 16) states: “The Babylonian mode of thought has been accused of advocating ‘anything goes’ . . . which seem to be putting forward the view that there is really no methodology. However, this characterization is not accurate. The Babylonian approach occupies a middle ground, between one set of rules and no rules. It advocates a set of methodological principles corresponding to a set of schools of thought.” While the Babylonian approach provides a methodology, it has problems establishing a consistent approach when doing Post Keynesian economics and an approach that is also faithful to Keynes’s revolution. Even Dow herself recognizes this. When confronted with the Sraffian long-run analysis, her response is: “It is difficult . . . to reconcile the methodology specified above [the Babylonian approach] with the Sraffian approach” (Dow, 2001, p. 18). Then she claims that we can justify not accepting the Sraffian approach because it represents a different “non-mainstream” school of thought; and although Post Keynesians should be open to the methodological approaches of other non-mainstream schools, it is a school that is distinct from others. But if the Post Keynesian methodological approach is an open system that does not rely “on a single formal method,” and accepts “a range of methods . . . [with] no single set of axioms” (Dow, 2001, p. 17), how is your methodological approach different from other schools of thought, and how can you accept one approach and not another without being ad hoc? It seems that Dow wants to have her cake and eat it too – saying that she is open to all methodological approaches and then arguing that certain methodological approaches, like the Sraffian one, are not acceptable because they contradict the Post Keynesian world view (Dow, 2001, pp. 18–19). Moreover, she distinguishes schools of thought by their world view. How do you come up with and define the principles of that world view outside your methodological approach? If your world view defines what methodological approaches are acceptable, then you do not have an open-ended methodological approach; instead, you have a helpful criterion to judge whether some methodological approach is acceptable or not. The importance of uncertainty in the Post Keynesian world view lets Dow reject the method of the Sraffians. It is possible to do the same thing with the other features mentioned earlier in this chapter. These features are essential, and can be looked at as axioms of the Post Keynesian approach. Because of their essential quality in the Post Keynesian world view, not all methods can be accepted. While I don’t have space here to develop the argument, I would say that the methods that can be used in Post Keynesian economic analysis are far more restrictive than the Babylonian approach suggests. The four features of Post Keynesian economics also provide a means for dealing with unresolved methodological issues, like the use of econometrics and the role of expectations. Dow wants to argue that the Post Keynesian methodological approach on these issues is “still evolving” and “provisional.” I want to argue that there is still debate on these issues, but the criterion for judgment is not provisional or evolving; they are embedded in the four features forming the heart of Post Keynesian economics. Until we back away from an open-ended methodological approach,

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we will constantly run into problems defining “Post Keynesian economics” and whether its true purpose is to carry out the revolutionary ideas of Keynes. Although I have focused on the Babylonian approach, some of my criticisms can also be used against the efforts to make critical realism the methodological foundation of Post Keynesian economics (Lawson, 1997). Walters and Young (1999) make a strong case against critical realism, but they refuse to admit that Post Keynesian economics has a coherent methodological and theoretical perspective. I would agree with them that “The tendency to dismiss all neoclassical economics as irrelevant and/or wrong is an unfortunate feature of Post Keynesianism that ought not to be encouraged.” I also agree that “This is not to suggest, however, that Post Keynesians need to abandon their concern with the realism of assumptions or indeed their skepticism regarding the primacy of prediction” (Walters and Young, 1999, p. 121). But while Post Keynesians should be skeptical about prediction, this does not mean that they should abandon all empirical work. To the contrary, Post Keynesians need to focus more on doing empirical work that examines the real world and they need to test their theories against mainstream theories. As Holt and Pressman (2006) argue, because both Post Keynesians and mainstream economists share certain definitions and have a common language, they can carry out a dialogue about the consequences of their differing views. For example, Post Keynesians and mainstream economists pretty much agree on definitions of savings and investment. They also agree that in a simple economy with (no government intervention and no foreign trade) savings and investment should be equal. Where the disagreement becomes apparent is when you start talking not about a simple exchange economy, but a more advanced developed capitalist economy where money and investment decisions play key roles. Since we have a shared terminology and views, we can have a debate about the relationship between savings and investment – i.e., does savings cause investment as the mainstream claim, or does investment determines savings as Post Keynesians believe (Holt and Pressman, 2006, p. 7). This approach is consistent with what I have been arguing throughout this chapter – that based on the revolutionary course outlined in the General Theory, Post Keynesians have a coherent approach to engage the mainstream, one that helps us understand how the real world works in an advanced capitalist system. So where do we go from here?

A look ahead So far I have argued that Keynes provided the groundwork for an intellectual revolution in economics. By questioning some basic assumptions, and bringing money and financial markets into the determination of output and employment, Keynes posed a challenge to the classical model that is still relevant today. His revolution is imbedded in the four features of Post Keynesian economics discussed above. They provide a vision to look at the economic problem as more than just a question of allocating scarce resources efficiently in a predictable world.

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Keynes saw economic problems existing within a social, institutional, and political setting, and in a world that is uncertain. These real-world characteristics distort markets and mean that public policy is necessary to stabilize advanced capitalist economies.6 Keynes held this cautious optimism because he believed that through social and political means, and the dedication of individuals with high professional standards, the economic problem could be solved. Such optimism could not be gotten from the neoclassical model because built into its assumptions is the view that the economic problem is a law of nature revolving around scarcity and self-interest. For Post Keynesians the task at hand is similar to the one Keynes (1971, p. 3) stated in Chapter 1 of the General Theory: “the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.” The classical theory to which Keynes refers provides the foundation for neoclassical thought today. It is represented in the neoclassical synthesis and the new classical critique of Keynesian economics that is leading us into a “misleading and disastrous” direction. Looking ahead, Post Keynesians must follow the two main goals Keynes set for himself when writing the General Theory. First, Post Keynesians need to get the theory right, and extend its logic, explaining how we might deal with economic problems like uncertainty and unemployment in the world we live in today. The second primary goal Keynes had in the General Theory, which has been pushed aside by methodological debates, is the establishment of public policies to improve economic performance and create a better world. Getting the theory right and establishing appropriate public policies are still relevant today, and Post Keynesians today need to do both and also illuminate the relationship between theory and public policies. While the goal for Post Keynesians is the same as it was for Keynes, the world has changed. Globalization is one important way that it has changed. By shifting from a closed economy (which Keynes focused on in the General Theory) to an open economy in a technological age, the theoretical and publicpolicy issues change. Keynes broke through the logic of Say’s Law in a closed economy and questioned the foundation of the classical model. Post Keynesians today need to take that insight and extend it to an open economy by challenging the gospel truth of comparative advantage.7 As Robert Prasch (1996) points out, neoclassical economists view comparative advantage in an open economy similar to how they look at Say’s Law in a closed economy. They start from the “specialty of microeconomics,” avoiding questions about the impact of comparative advantage on employment, distribution of income, and the levels of effective demand within a particular country. Like Say’s Law, comparative advantage holds true only under limited circumstance. But these conditions do not hold in the world we live in today, with flexible exchange rates and high levels of world-wide unemployment. Similar to the 1930s economic policies that were based on Say’s Law, today we find ourselves with a theory that can lead to

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world-wide economic disaster. At best, economists are advocating policies that will not achieve global full employment but will continuously put countries in harm’s way. From World War II to the late 1960s, the world saw high levels of growth with low rates of unemployment and acceptable levels of inflation. Starting in the early 1970s, a sequence of events led to high rates of unemployment and high inflation. The fear of inflation led governments in the 1970s to focus on restrictive aggregate demand policies. This helped reduce inflation, but created higher rates of unemployment in industrial countries compared to a decade earlier. Policies, strongly influenced by the views of the financial sector, were put into place that emphasized price stability rather than full employment as a primary goal. Keynes believed that the adverse effects of anticipated inflation can be compensated for by creative institutional changes. Unemployment on the other hand is an unambiguous loss to society, and can contribute to poverty, disease, homelessness, racial antagonism, and crime. The 1970s also saw the breakdown of the Bretton Woods agreement, which had a significant impact on the global economy. The end of Bretton Woods introduced flexible exchange rates and efforts to deregulate international capital markets. The consequence of these policies became evident in the 1980s with the debt crisis that plagued Mexico and other Latin American countries, and in the 1990s with the Asian crisis, where we saw significant currency devaluation and international capital outflows, guided by fears of exchange rate and interest rate speculation. As long as the current international trade policies stay in place, we can expect to see economic instability in the decades ahead. To respond to our current social and economic needs, Post Keynesians must take the initiative at both the theoretical and the political level. First, theoretical discussions with our mainstream colleagues must point out that comparative advantage is not applicable in a money-using world economy where there is not full employment. Also, comparative advantage only works on the assumption that there is restricted capital and labor mobility. If labor is unable to move easily and quickly, as we see in today’s international economy, then the country with the lowest unit labor costs can find itself with full employment while its trading partners struggle with falling wages and unacceptable rates of unemployment. If politicians fear capital flight, and become reluctant to stimulate their economies using domestic spending and tax policies, export-led growth provides the only way to expand domestic employment. This has been the main policy used to stimulate growth and employment for the last two decades, but it has not led to world-wide full employment or to international economic stability. Moreover, by definition, not every economy in the world can grow by running trade surpluses. So we have an international game of who can lower their nominal labor costs or devalue their currency the most. As we have seen in Latin America, and recently in Asia, such a game has large costs. As Keynes (1971, p. 345) pointed out, “the mercantilists were aware of the fallacy of cheapness and the danger that excessive competition may turn the terms of trade against a country.” Such actions would reduce national living standards. There is a

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healthy debate among Post Keynesians about whether we should have fixed exchange rates or flexible rates, and whether we should have capital controls or free capital flows; but as John Smithin (2001) points out, Post Keynesians agree on the goals of international trade and exchange – that it should contribute to world-wide full employment and economic stability. This leads to our political initiative. We need international public policies that help create world-wide economic stability and full employment. Keynes recognized the fear of capital flight and how it might affect a nation’s ability to carry out domestic fiscal and monetary policies. He wanted to end currency speculation in order to achieve a strong and health world economy, “Nothing is more certain than that the movement of capital flows must be regulated” (Keynes, 1980, p. 25). This requires reducing the international speculative pressures that have contributed to economic disruption, as, for example, occurred in Asia for example during the 1990s. There also needs to be a new international payments system. As Keynes (1980, p. 27) pointed out: It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on a country which is the debtor position on the international balance of payments – that is, on the country which is (in the context) by hypothesis the weaker and above all the smaller in comparison with the other side of the scales which (for this purpose) is the rest of the world. The existing system simply forces debtor nations to “tighten their belts” by carrying out contractionary economic policies. To achieve global full employment, surplus countries must take the responsibility for balance of payments adjustments through employing expansionary policies. Only in this way can we hope to achieve sustainable economic growth and full employment in the world. Post Keynesians must always remember that high levels of economic activity also lead to high levels of aggregate demand. We are frequently reminded by our orthodox brothers and sisters of the economic problems of NAIRU, and the laissez-faire virtues of flexible exchange rates and international capital mobility. And they are right – if you accept the assumptions of the classical economists. If you accept the economic problem as defined by neoclassical economists, then we will always face a tradeoff between inflation and unemployment, and the world economy will suffer from economic instability as well as great income and wealth inequality But by following a more general theory, one that assumes uncertainty, that money is not neutral, and that institutions and public policy can create economic stability in the world, we might break away from the old economic problem “of want and poverty and the economic struggle between classes and nations” (Keynes, 1963, p. vii). Instead, we will find ourselves in a civilized world of full employment and sustainable prosperity. In the 1930s Keynes foresaw a time when attitudes surrounding the economic problem would be based on the good, rather than issues of scarcity and efficiency, and the money motive would be assessed at its true value, as distasteful and unjust. The policy

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recommendations of Post Keynesians could precipitate this change much sooner than Keynes expected, if we stay the course and remember the hope that Keynes (1963, pp. vii–viii) gave us: The author . . . for all his croakings, still hopes and believes that the day is not far off when the Economic Problem will take the back seat where it belongs, and that the arena of the heart and head will be occupied, or reoccupied, by our real problems – the problems of life and human relations, of creation and behaviour and religion. And it happens that there is a subtle reason drawn from economic analysis why, in this case, faith may work. For if we consistently act on the optimistic hypothesis, this hypothesis will tend to be realized; whilst by acting on the pessimistic hypothesis we can keep ourselves for every in the pit of want.

Notes 1 Davidson (1994, p. 17) defines Post Keynesian economics in terms of its rejecting three neoclassical axioms: (1) money neutrality, (2) the gross substation axiom, and (3) the axiom of an ergodic system. 2 As Asimakopulos puts it: “Keynes tried to develop a theory that would be relevant to the capitalist economies of his day, economies that existed in historical time” (Asimakopulos, 1991, p. 3). 3 All notions of “equilibrium” and “central tendency” are rejected out of hand. It is the innovations and adaptations of capitalism that command attention. Historical conditions and historical time take precedence over mechanical equilibrium models operating in logical time. And since capitalism is essentially and profoundly a credit-money economy, financial structures and their innovations over historical time are of prime importance. (Rousseas, 1986, p. 12) 4 Because these procedures do not rely on optimizing behaviour, they are usually considered as instances of market failures and are called, sometimes disdainfully, rules of thumb. However, in a world of ignorance and of complexity, these rules of thumb are rational. There are many examples of rules of thumb in the real world: mark-up pricing; financial ratios of all sorts, and all bureaucratic rules. (Lavoie, 1992, pp. 55–59) 5 Much of the discussion of behaviour has taken place at the level of the individual in isolation, but in doing so there is considerable danger of forgetting the role of organisations and institutions. Economists from the Austrian school as well as some post Keynesians have been particularly prone to this. But the large corporation is a clear factor of the developed capitalist world, as are governments, trade unions, households, etc. One part of the significance of large (and no so large) organisations is that such organisations wield considerable economic and political power. (Sawyer, 1995, p. 61) 6 Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about;

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and these same factors are also the cause of the Unemployment of Labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease. I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution . . . These measures would involve Society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered. (Keynes, 1963, pp. 317–318)

References Arestis, P. (1992) The Post Keynesian Approach to Economics (Aldershot: Edward Elgar). Asimakopulos, A. (1991) Keynes’s General Theory and Accumulation (Cambridge: Cambridge University Press). Buchanan, J. and Wagner, R.E. (1978) Democracy in Deficit: The Legacy of Lord Keynes (New York: Academic Press). Davidson, P. (1982) International Money and the Real World (London: Macmillan). Davidson, P. (1994) Post Keynesian Macroeconomic Theory (Aldershot: Edward Elgar). Dostaler, G. (1988) La theorie post-keynesienne, la: Theorie Generale et Kalecki, Cahiers d’Economie Politique, 14–15, pp. 123–142. Dow, S. (1996) The Methodology of Macroeconomic Thought (Aldershot: Edward Elgar). Dow, S. (1997) Methodological pluralism and pluralism of method, in A. Salanti and E. Screpanti (eds) Pluralism in Economics: Theory, History and Methodology (Aldershot: Edward Elgar), pp. 89–99. Dow, S. (2001) Post Keynesian methodology, in R. Holt and S. Pressman (eds) A New Guide to Post Keynesian Economics, (London: Routledge), pp. 11–20. Dunn, S. (2000) Whither Post Keynesianism, Journal of Post Keynesian Economics, 20, pp. 345–64. Galbraith, J.K. (1985) The New Industrial State, 4th ed. (Boston: Houghton Mifflin). Galbraith, J.K. (1994) A Journey through Economic Time: A Firsthand View (Boston: Houghton Mifflin). Harcourt, G. (1999) Horses for courses: the making of a Post Keynesian economist, in A. Heertje (ed.), The Makers of Modern Economics, Vol. IV (Cheltenham, UK: Edward Elgar), pp. 32–69. Holt, R. and Pressman, S. (2006) Empirical Post Keynesian Economics: Looking at the Real World (Armonk, NY: M.E. Sharpe). Holt, R. and Setterfield, M. (1999) Time, in P. O’Hara (ed.) Encyclopedia of Political Economy (London: Routledge Press), pp. 1158–1161. Keynes, J.M. (1963) The end of laissez-faire, in Essays in Persuasion (New York: W.W. Norton), pp. 323–338. Keynes, J.M. (1971) The Collected Writings of John Maynard Keynes, Vol. XIII, The General Theory of Employment, Interest and Money (London: Macmillan). Keynes, J.M. (1973) The Collected Writings of John Maynard Keynes, Vol. XIV, The General Theory and After (London: Macmillan). Keynes, J.M. (1980) The Collected Writings of John Maynard Keynes, Vol. XXV, Activities 1940–1944: Shaping the Post-War World: The Clearing Union (London: Macmillan).

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Kregel, J.A. (1973) The Reconstruction of Political Economy: An Introduction to PostKeynesian Economics (London: Macmillan). Laramie, A., Mair, D. and Miller, A. (2006) Kalecki’s investment theory: a critical realist approach, in R. Holt and S. Pressman (eds) Empirical Post Keynesian Economics: Looking at the Real World (Armonk, NY: M.E. Sharpe), pp. 178–201. Lavoie, M. (1992) Foundations of Post-Keynesian Economic Analysis (Aldershot: Edward Elgar). Lawson, T. (1997) Economics and Reality (London: Routledge). Lucas, R. (1981) Studies in Business Cycle Theory (Cambridge: MIT Press). Mankiw, N.G. (1992) The reincarnation of Keynesian economics, European Economic Review, 36, pp. 560–561. Mearman, A. (1998) Keynes, realism and econometrics, paper presented to the Third Annual Postgraduate Economics Conference, Leeds, November. Nell, E.J. (1988) Prosperity and Public Spending: Transformational Growth and the Role of Government (Boston: Unwin Hyman). Nell, E.J. (1994) On transformational growth, Review of Political Economy, 6 (1), pp. 107–134. Pearce, D. (1989) The MIT Dictionary of Modern Economics (Cambridge: MIT Press). Prasch, R. (1996) Reassessing the theory of comparative advantage, Review of Political Economy, 8 (1), pp. 37–55. Pressman, S. (2001) The role of the state, in R. Holt and S. Pressman (eds) A New Guide to Post Keynesian Economics, (London: Routledge), pp. 102–113. Robinson, J. (1962) Essays in the Theory of Economic Growth (London: Macmillan). Rousseas, S. (1986) Post-Keynesian Monetary Economics (London: Macmillan). Sawyer, M. (1995) Unemployment, Imperfect Competition and Macroeconomics: Essays in the Post Keynesian Tradition (Aldershot: Edward Elgar). Smithin, J. (2001) International monetary arrangements, in R. Holt and S. Pressman (eds) A New Guide to Post Keynesian Economics, (London: Routledge), pp. 114–25. Walters, B. and Young, D. (1999) Is critical realism the appropriate basis for Post Keynesianism?, Journal of Post Keynesian Economics, 22 (1), pp. 105–123.

7

Aggregate demand and supply John Smithin

Introduction Ingrid Rima is a distinguished labor economist and historian of economic thought, who has frequently used the Keynes/Post Keynesian model of aggregate demand and supply (in Z,N space) to good effect in her own work. In her definitive Development of Economic Analysis (1996, 495) she (rightly) describes this construct as representing “Keynes’s aggregate demand and supply schedules,” even though Keynes (1936) did not actually offer a graphical exposition. This was due to the work of such “Post Keynesian” writers as Davidson and Smolenksy (1964) and Weintraub (1961). There are also expositions of Keynes’s theory in Chick (1983, pp. 62–81), Davidson (1994, pp. 18–29), and Patinkin (1976, pp. 83–94; 1982, pp. 123–53). The field of macroeconomics would arguably be much further ahead had this framework been more widely accepted as definitive, but AD/AS concepts have since evolved considerably, and in divergent directions. The objective of this chapter is to review and critique the main variants, and to suggest a different approach, which, if not able to “reconcile” the existing alternatives, will at least make clear the differences and similarities between them. Also, to show how this avoids the charges of logical inconsistency and theoretical error leveled at some of the other constructs (Barro, 1994; Colander, 1997; Bhaduri et al., 1999). There are three caveats to be made at the outset. First, following most of the literature, the chapter attempts only a static aggregative analysis (that is, of a model determining the level of output rather than the growth rate).1 Second, the discussion is restricted to the case of the closed economy. Third, again conventionally, changes in “autonomous demand” are treated as exogenous. The argument takes a chronological approach, starting with the original Keynesian model, and it is shown that issues arising in that context carry through in all subsequent debates. The penultimate section of the chapter provides a synthetic AD/AS model, which attempts to address each of the various issues and problems discussed.

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The theory of “effective demand” Chick (1983, p. 65) makes clear the distinction between aggregate demand as such and effective demand: “effective demand, in contrast to aggregate demand, is not a schedule – it is the point on the schedule . . . which is ‘made effective’ by firms’ production decisions.” This means that the principle of effective demand is actually missing from the standard presentations of AD/AS analysis in most textbooks. Such constructs do have an aggregate demand schedule, derived in its most basic form by re-arranging the equation of exchange, MV  PY. However, typically demand plays no role in determining output, which depends only on supply-side factors involving technology and the labor market (Chick, 2000, p. 124). As shown by Rima in the source quoted above, Keynes’s (1936, pp. 23–5) original functions were upward sloping in Z,N space, where Z is “the expectation of the proceeds [from each level of employment] which will just make it worth the while of the entrepreneurs to give that employment,” and N is the level of employment. In equilibrium, the supply function Z is equal to the demand function D, defined as the “proceeds . . . entrepreneurs expect to receive from the employment of N men.” In the graphical versions, with nominal GDP (PY) on the vertical axis, Z cuts D from below, defining the point of effective demand at e. (See Figure 7.1.) Inferences about the slope of the supply function are based on reconstructions from the GT text. Key among the textual clues are, first, Keynes’s (1936, p. 28) Z,D Z e

D

0

Figure 7.1 Keynes’s Z and D schedules.

N

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definition of “involuntary unemployment.” Second, his joint acceptance of the “first postulate” of classical economics (that the real wage is equal to the marginal product of labour under competitive conditions), and rejection of the “second postulate” that it is equal to the “marginal disutility of employment” (Keynes, 1936, p. 5). The implication is that employment determined by effective demand is a position on a conventional labor demand curve, but off the labor supply curve (Patinkin, 1982, pp. 133–37; Chick, 1983, pp. 72–74). With a production function subject to diminishing returns [Y  Y(N), Y(N)  0, Y   0], and if W/P stands for the real wage, the Z curve emerges as an explicit function of N: Z  PY  WY(N)/Y(N)

(1)

The demand function is similarly a function of N, and Keynes wrote this explicitly as: D  f(N)  (N)  D2

(2)

where (N) is consumption spending, and D2 is investment. The theory can also be expressed in real terms, deflating nominal values by the “wage unit” (Patinkin, 1982, pp. 129–30). On the assumption of “homogenous labor” (Chick 1983, pp. 68–69), this can be identified with the nominal wage W. Using the usual C and I notation for consumption and investment (Keynes 1936, pp. 90, 115), the demand side in wage units becomes: Dw  C(Yw)  Iw

(3)

Also “real income in wage units” is Yw  Y(N)/Y(N). Hence, demand and supply functions in wage units are given by: Dw  C(Y(N)/Y(N))  Iw

(4)

Zw  Y(N)/Y(N)

(5)

To illustrate assume C(Yw)  c Yw where c is the “propensity to consume” (0  c  1), and, following Patinkin (1982, pp. 134–35), that the production function takes the form Y  A0N , with 0   1. The slope of the supply function is then 1/ , which is greater than one, and steeper than the slope of the demand function, c/ , as illustrated in Figure 7.2. Patinkin (1982, pp. 123–58) has three criticisms to make about the theory as reconstructed above. The first relates to Keynes’s statement (1936, p. 25) that at the point of effective demand “the entrepreneur’s expectation of profit will be maximized.” As Patinkin shows, this is not literally true. There are other positions at which profits are absolutely greater. Nonetheless, e is certainly the market equilibrium, so the “incorrect” statement does not invalidate the theory

Aggregate demand and supply Zw, Dw

111

Zw e Dw 45°

e'

0

N1

N*

N

Figure 7.2 Aggregate demand and supply in wage units.

per se. In a related vein, Patinkin (1982, pp. 144–50) questions whether Keynes’s treatment is consistent with the marginalist approach to economic theory, due to the footnote in which Keynes (1936, p. 55) sets out conditions for the supply curve to have a slope of unity. This shows that at least on one occasion Keynes identified supply “. . . not with the profit-maximizing supply curve . . . but . . . the 45° radius . . . representing total variable costs” Patinkin (1982, p. 144). In Patinkin’s view this apparent error in applying marginalist principles reflects a continuing influence of the method of Keynes’s Treatise on Money (1930) on the exposition of the General Theory itself. Again, however, the issue of whether the macroeconomic supply curve is derived on marginal or average cost principles makes no difference to the substance of the theory itself. The equilibrium would simply be at e rather than e. (It does raise the question of whether Keynes made a tactical error in introducing marginalist ideas into monetary macroeconomics, hence paving the way for this type of discussion.) Patinkin’s third criticism, however, does involve a key issue from the macroeconomic point of view. This is whether the demand or supply curve should be seen as embodying entrepreneurs’ expectations. There are different views on this. Chick (1983, p. 63) explicitly labels the D curve as De (for expectations), whereas according to Weintraub (1961, pp. 35–36) the demand curve represents “actual outlays” as opposed to the “expected outlays” of the supply curve. Patinkin (1982, pp. 126–27) argues that there is a contradiction if (e.g., at N1) firms/entrepreneurs are held to simultaneously hold the two different

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expectations of “proceeds” suggested by the Z and D curves. His solution, like that of Weintraub, is to take the supply function as embodying expectations, and the demand curve actual outcomes. Although each of these potential problems with Keynes’s exposition could be resolved by making the appropriate adjustments to the narrative (Patinkin, 1982, p. 153), there still remains the genuine Achilles heel of the Keynes theory, which is the main threat to its credibility in the eyes of orthodox economic theorists. Having introduced the classical postulates, and a general presumption that the economy studied operates under competitive conditions (Keynes, 1936, pp. 5–7, 17–18), the question is bound to be asked why the first postulate is deemed to hold and not the second. The answer can only be some type of wage “rigidity” or “stickiness,” which (e.g.) in an economic downturn, prevents real wage adjustment as prices fall, and hence allows for “involuntary unemployment” (Keynes, 1936, p. 15). This charge of an arbitrary assumption of rigid or sticky wages was exactly the grounds on which the Keynesian approach was dismissed as theoretically inadequate by textbooks of the later twentieth century (Salant, 1985, p. 1180). In fact, Keynes’s (1936, p. 15) definition of involuntary unemployment2 does leave the impression that failure of labor markets to “clear” must be an important part of the explanation (Chick, 1983, pp. 72–4; Smithin, 1985). Keynes (1936, 27) also claimed that “the . . . character of the argument is precisely the same whether or not money-wages . . . are liable to change,” and contributed a chapter on “changes in money wages” (Keynes, 1936, pp. 257–79). Again, however, the latter bears out Patinkin’s (1976, pp. 105–07) interpretation of a theory of sluggish adjustment rather than underemployment equilibrium (Smithin 1984, 1988). In the graphical presentation, imposing the “anti-Keynesian” assumption of labor-market clearing under competitive conditions picks out a unique real wage, and a unique level of employment, along the Z curve at N*, thus ruling out any influence of effective demand. The D curve would simply have to adjust to the given level of employment, as in “Say’s Law.” After Keynes, the next step in the evolution of AD/AS analysis was Samuelson’s simplification in the “Keynesian cross” diagram (not illustrated). This is “the familiar diagram which has served to translate the central message of the General Theory to generations of economics students” (Patinkin, 1982, p. 9). The aggregate demand function is still upward sloping, this time in E,Y (expenditure/income) space, and it can still be claimed that output is determined by effective demand. However, the role of aggregate supply is obscured. Keynes’s aggregate supply function is replaced by the “45° line,” illustrating the national income identity, E  Y, and the impression is given that only demand matters for the determination of output. Patinkin (1982, p. 152) suggests that the 45° line could be treated as a supply curve, assuming “. . . that every point . . . corresponds to a different real wage rate.” However, “admittedly, it generally was not.” Kaldor (1983, pp. 11–15) argues that the key strategic error made by Keynes in all this was the attempt to combine the theory of effective demand with neoclassical notions of perfect competition. Instead, the correct foundation for a theory of effective demand would be a generalized notion of imperfect competi-

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tion at the macroeconomic level. According to Kaldor (1983, p. 14), “the acceptance of Marshallian microeconomics” on the part of Keynes was a mistake. In effect, the theory of perfect competition ultimately assumes that firms can sell all they like at the going price. But, on the contrary, “the very notion of production in the aggregate being limited by demand [should presuppose] a state of affairs in which the production of individual firms in industries of all kinds is limited by lack of orders and not by productive capacity . . . the individual producer faces a limited demand for his product – not an infinitely elastic demand . . .” (Kaldor, 1983, p. 11). Hence, the competitive marginalist condition should be replaced by: P  [(1  )/ ][W/Y(N)]

(6)

or a similar version involving average cost pricing, where is “the . . . [aggregate of] the elasticit[ies] of demand facing the individual producer[s]” (Kaldor, 1983, p. 17). This does, in fact, turn out to be the crucial issue on the supply side of a theory of aggregate demand and supply, as is shown below.

The “textbook” AD/AS construct Graphical constructions with upward-sloping aggregate demand schedules are quite different in spirit from the expositions in P,Y space, the mainstay of the textbooks. In the latter framework the aggregate demand curve is downward sloping, and by the 1970s, this version was firmly entrenched in intermediate level texts. One reason for the change was the inadequate treatment of aggregate supply in the Keynesian Cross. However, it was also productive of much confusion for subsequent generations of beginning students. In “Economics 101” the old upward sloping aggregate demand schedule continues to be taught to this day. In second year, however, the downward sloping version is the main model, and it is a real challenge for students to grasp the connection between the two. On the slope of the aggregate demand curve Chick (2000, p. 124) makes explicit that in Keynesian or Post Keynesian treatments the assumption should be made that increases in demand are accompanied by endogenous changes in the money supply. The neoclassical version, however, is predicated on a fixed nominal money supply, and in that case demand must be negatively related to the price level. Although not logically entailed by the change of axes, use of the neoclassical P,Y construct can also be supplemented by an assumption that the aggregate supply function is vertical. This picks out a unique full employment level of output Y* (corresponding precisely to N* above). The downgrading of supply is thereby reversed, but at the same time the principle of effective demand is ruled out, except in the ill defined short run. The simplest possible version would be: P  MV/Y

(7)

Y  Y*

(8)

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P LRAS

P1 AD

0

Y*

Y

Figure 7.3 Aggregate demand and supply in P,Y.

where (7) is a rectangular hyperbola derived from the equation of exchange, and Y  Y* defines the (vertical) “long run aggregate supply curve” (LRAS). (See Figure 7.3.) This type of analysis is actually not subject to the charge of theoretical inconsistency leveled at more ambitious versions of the textbook approach. Output is always at the full-employment level Y*, while monetary demand is given by (7). The equilibrating factor is simply a change in prices. Output and employment are determined by supply conditions, and money-supply changes (given velocity) determine prices. It is simply an adumbration of the quantity theory. There is a hybrid version of the above, however, which, according to Barro (1994, p. 1) “allow[s] for supply shocks in a Keynesian [sic] framework and [attempts] to generate more satisfactory predictions about the behavior of the price level.” Barro argues, however, that this version does involve “logical inconsistencies” and that, therefore, “the model is unsatisfactory and should be abandoned as a teaching tool.” Bhaduri et al. (1995, 1999) make a similar case, and point out that the model is used not only for teaching but also as a basis for more advanced empirical work identifying demand and supply “shocks.” Doubts about the model would therefore invalidate the results of this entire body of literature. Based on profit-maximizing behavior, and with a rigid nominal wage (or mistaken expectations), the hybrid model postulates a positive relationship between output supplied and the aggregate price level:

Aggregate demand and supply Y  G(P),

115

G(P)  0

(9)

This however is explicitly “short run,” while the long-run relationship is always supposed to revert to that in (8). Meanwhile there is a negative relationship between output and prices on the demand side, derived from one version or another of a familiar IS/LM exercise (Barro, 1994, p. 2). The short-run model therefore comprises a downward-sloping aggregate demand function and an upward-sloping short-run aggregate supply curve (SRAS) (see Figure 7.4). The reason this construct is accused of logical inconsistency can be seen by considering an out-of-equilibrium price level such as P1 (Barro 1994, p. 3; Bhaduri et al., 1995, pp. 3–4). Given profit-maximization firms are supposed to supply the amount of output Ys, and offer the associated level of employment. At the same time output demanded is Yd. This level of demand, however, is supposedly generated by a multiplier process in which each successive increment to demand depends on actual income. Therefore, it must somehow also be assumed that the level of employment is simultaneously that associated with Yd. According to Bhaduri et al. (1995, p. 6) the contradiction arises “from subjecting the same economic agent, namely the firm, to two different rules of behaviour – profit-maximization along AS versus satisfying aggregate demand along AD.” There are, however, “two routes to consistency” in reconstructing the analysis. Either it must be assumed that the economy is always on the supply curve or, alternatively, invoking the principle of “bounded rationality,” that

P

SRAS

P1

AD 0

Ys

Yd

Figure 7.4 Aggregate demand and supply in the “short run.”

Y

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firms typically produce to satisfy aggregate demand and the supply curve is irrelevant below full employment. The authors argue for the latter route, observing that this is consistent with Kalecki’s (1971) approach to macroeconomics. Note, however, that the issue raised here is the same as in the interpretation of Keynes’s original Z and D functions (namely, which of the two embodies firms’ expectations), and recall that some Post Keynesians (as opposed to Kaleckians)3 have made the alternative argument that the Z or supply function takes priority, whether or not as a result of profit maximization per se. In Bhaduri et al. (1995, 1999), the solution prioritizing the supply curve gives rise to an alternative version of aggregate demand, which the authors label “derived aggregate demand” (DAD). The level of income that enters into the consumption function on the demand side is taken to be the same as the current supply of output. Therefore, substituting in from (9): Y  cG(P)  I

(10)

This implies that the DAD function is upward sloping, unambiguously so in the case where investment is exogenous. (See Figure 7.5.) A number of authors including Fields and Hart (1990), Colander (1995, 1997), and Dutt (1997) have proposed solutions involving the DAD curve or similar. Bhaduri et al. (1995, 1999), however reject this type of construction. In their view, models in the “Keynesian tradition” should allow for a direct impact

P

SRAS

DAD

P1

0

Figure 7.5 A positively-sloped DAD curve.

Y1

Y

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of aggregate demand on output/employment, and not assign a main causal role to supply adjustments (Bhaduri et al., 1999, pp. 286–7). As mentioned above, however, it is not clear that this argument is justified as applied to the model of the General Theory, which does have a detailed demand/supply approach.

Aggregate demand and supply in r,y space It would be fair to say that the aggregate demand and supply diagram in P,Y space remains the staple of the textbooks. However, there is still another version, which made its first appearance at the intermediate textbook level in Barro (1984). This is the “market-clearing model” (Barro, 1984, pp. 123–47), also known as the “real business-cycle (RBC) model” (Mankiw, 1992, pp. 374–78; Snowdon and Vane, 1997, pp. 17–20; DeLong, 2002, pp. 466–70). This changes the coordinates of the diagram yet again, making aggregate demand and supply schedules appear in r,Y space, where r is the real rate of interest (Barro, 1984, p. 128). In Figure 7.6, the Cd (demand for commodities) or aggregate demand schedule is negatively sloped with respect to the real rate of interest, and the supply curve, Ys, is positively sloped. This formulation is not, however, the same as Hicks’ (1937) demand side IS/LM model. There may be an analogy between a standard IS curve and the Cd schedule. However, there is no direct discussion of monetary issues, and no analogue to the Hicksian LM curve. The model exhibits

r

Ys

Cd

0

Figure 7.6 The market-clearing AD/AS model.

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a purely “real theory of the real rate of interest” rather than a “monetary theory of the real rate of interest” (Burstein, 1995, p. 1), and the role of money is only to determine the price level (Barro, 1984, p. 130). The model infers aggregative schedules from a real theory of inter-temporal choice applied to a “representative agent,” with the marginal conditions: MRSC  1  r

(11)

MRSN  (1  r)[w1/w2]

(12)

where MRSC is the marginal rate of substitution between present and future consumption, MRSN is the marginal rate of substitution between work effort in the present and future, and the wi are real wage rates in both periods. From this exercise an argument can be constructed that an increase in the interest rate will reduce the demand for consumption goods in the current period, and at the same time increase work effort and the supply of output. This is the “inter-temporal substitution” theory of labor supply. In evaluating this argument, there are obvious problems with the attempt to derive specifically macroeconomic arguments from a purely individualistic theory of choice, even though this has become a methodological obiter dicta in the contemporary “microfoundations” literature. This point aside, however, in the context of the evolution of AD/AS analysis the most interesting feature of the re-labeling of the axes is that now neither of the schedules has a vertical slope. Therefore, at least in principle, there may now be scope once again for effective demand as a factor determining output and employment. Any increase in demand, not offset by a compensating shift in supply, must cause an increase in output and employment. Presumably, this was not the intention of the originators of the market-clearing model, and if the Cd,Ys schedules really are only different facets of the same optimization problem, it may not work out this way as the schedules will not be independent. However, changing the domain of the exercise to r,Y space does suggest that further consideration of these relationships, not necessarily based solely on the representative agent framework, might recover some of the insights about effective demand from the earlier literature. Snowden (1997, pp. 18–20) also stress that the demand and supply schedules in the RBC model are “long run” constructs (in the sense of not depending on such assumptions as sticky nominal wages, etc.), as opposed to textbook Keynesian short-run analysis. Another issue raised by the move to r,Y space is that once again (as in the original Keynesian model) the aggregate demand and supply apparatus is confined to determining the real variables of the system only. It does not simultaneously determine the price level or the inflation rate, and these must explained by some other set of macroeconomic principles. Fields and Hart (2003) do show how the r,Y and P,Y models can be reconciled by the addition of a “loanable funds” money market, for example, but the point remains. The even more recent “new consensus” macro model (Romer, 2000; Taylor, 2000) does once again bring

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together the inflation rate (or the price level in a static version) and the level of output in the same diagram, but only via the device of making the central bank explicitly respond to changes in the inflation rate (or price level). This model retains the AD schedule from Figure 7.6, but abolishes the upward-sloping supply schedule, and reverts to the idea of a vertical LRAS at some natural rate of output. In the static version the demand schedule is then made downward sloping with respect to the price level by making the central bank raise (real) interest rates whenever the price level exceeds some arbitrary target. Hence demand and supply curves can be shown once again in P,Y space. Adding a positively sloped short-run supply curve, or even a completely flat SRAS curve, will then give a construct that visually resembles a hybrid of Figures 7.3 and 7.4. Equilibrium is achieved by appropriate shifts of the short-run schedules. It is clear, however, that the price level would remain indeterminate were it not for the deliberate central bank response. A “general theory” of aggregate demand and supply Figure 7.7 below suggests an alternative presentation of aggregate demand and supply in r,Y space (Smithin, 2002, p. 153), reverting to the notation of AD and AS. There are three important differences between the models presented in Figures 7.7 and 7.6. Also, there is one point in common with both the RBC model and the original Keynesian model, in that the AD/AS framework is taken only to determine real variables. r AD

r2

r1

e

AS 0

Figure 7.7 The downward-sloping AS curve in r,Y space.

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As to the differences, first the aggregate supply function slopes downward with respect to the real interest rate rather than upward. The argument for this is that, in any realistic description of a production process that takes time, the real interest rate must enter as an element of the costs of production (Smithin 1986, 1997; MacKinnon and Smithin, 1993). Therefore, an increase in the real interest rate should always reduce the demand for labor, whatever its impact on labor supply. It is further assumed that this demand effect will offset any plausible substitution effect, leading to a negatively sloped overall aggregate supply curve (Smithin, 1986). Second, the aggregate demand function is assumed to be less sensitive to changes in the interest rate than is aggregate supply, and hence cuts AS from above. The relative interest insensitivity of aggregate demand was of course a staple of the “old Keynesian” literature, but in that context it was not combined with a palpable degree of interest sensitivity of supply as is done here. In Figure 7.7 the AD is actually made completely inelastic with respect to interest rate changes, as in Smithin (2002). However, it is not vulnerable to the critique regarding derived demand, as explained below. Third, the (real) rate of interest is taken to be a financial variable, determined essentially by the monetary policy of the central bank. It is determined outside the aggregate demand and supply nexus itself, and shows up as a horizontal line across the page, at a pre-determined level. The underlying monetary theory is therefore similar to that of the Post Keynesian “horizontalist” school, in which the interest rate (including the real rate) is effectively a policy instrument, and the money supply is endogenous. This is contrasted with the version in Figure 7.6, where money does not appear, and the interest rate is taken to be non-monetary variable. As for consistency between the demand and supply curves, it should be conceded that the only legitimate starting point is the original equilibrium at “e”. At this point, the interest rate, the AD and the AS schedules are all mutually consistent. What happens, though, if (e.g.) the interest rate is arbitrarily raised as a matter of monetary policy? Heuristically, if we stick to the rule that the level of output is decided by firms, actual output will fall. In the first instance, therefore, profit expectations are likely to be to exceeded, thus giving rise to further adjustments of both demand and supply, and eventually some new equilibrium. The new equilibrium will be the outcome after the shifts have taken place, and demand, supply, and the interest rate are all once again consistent. The actual comparative static results should indeed refer only to comparisons between these equilibrium points, but the question remains what the adjustment mechanism might be. In neoclassical or new classical theory, interest rate adjustment itself is supposed to be equilibrating mechanism. However, this is ruled out by assumption in a “monetary” model and some other route must be found. Picking up on the importance of imperfect competition, as in Kaldor’s discussion above, it will be suggested that changes in the aggregate mark up may provide one such mechanism. Moreover, this seems to be the route most consistent with the actual functioning of a “capitalist” economy.

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Recall that the Patinkin/Weintraub interpretation of Keynes suggest that the actual level of output in AD/AS should be given by the supply curve, with AD showing the level of demand actually realized. One means of emphasizing this point is the device of a one-period production or marketing lag (Smithin 1986, 1997). Palley (1996, pp. 71–86; 1997) calls this the “Keynesian theory of aggregate supply,” precisely because of the analogy to Keynes’s discussion. However, there is a clear implication that something of this kind would have served Keynes’s purpose better than the original exposition lacking a sequence analysis. Therefore, if N(t) is labor input and A(t) is labor productivity let a simple macroeconomic production function be given by: Y(t)  A(t)N(t)

(13)

However, also assume that this output will not actually be brought to market until the next period (t  1). The “expected proceeds,” corresponding to Keynes’s “Z”, will therefore be: Z  P(t  1)Y(t)  [1  k(t)][1  i(t)]W(t)N(t)

(14)

where W(t) is the nominal wage rate, and i(t) is the nominal interest rate. The symbol k(t) is the anticipated mark-up or profit share on output produced in t (actually realized in t  1) and the inclusion of this term reflects the specification suggested by Kaldor in (6) above. Meanwhile, the nominal interest rate now appears on the cost side due to the time lag. Adopting the convention that lowercase notation stands for the logarithm of the corresponding upper-case variable, equation (14) then becomes: a(t)  r(t)  k(t)  [w(t)  p(t)]

(15)

where r(t) is the real rate of interest. This expression is basically an identity showing how output per head is distributed between rentiers, entrepreneurial profit, and real wages. What remains is to add some hypothesis about how each of the variables in this expression is determined. For the sake of simplicity we assume that productivity is a given parameter a(t)  a.4 Interest rates are dictated by monetary policy r(t)  r, and k(t) itself is one of the endogenous variables to be determined. Therefore, all that is required to complete the supply side is some hypothesis about the determination of real wages. As discussed above, one of the main features of Keynes’s (1936) treatment of real wage behavior was the assumption of diminishing returns and perfect competition. Hence, the presumption of the General Theory, and much of the literature that followed, was that employment and output can increase only if real wages fall. In particular, such a relationship was seemingly required to make any sense of the distinction between “voluntary” and “involuntary” unemployment. However, the evidence has never really supported the idea that real wages fall as output increases over the business cycle,5 and the following is

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therefore a more plausible specification, as long as the parameter h conforms to the stated restrictions: w(t)  p(t)  w0  hy(t),

0h1

(16)

The real wage equation therefore has an exogenous component, w0, presumably determined by various sociological and political factors, and also depends positively on the level of output. Equation (16), however, should not be taken as deriving from a microeconomic theory of labor/leisure choice. If it is interpreted as suggesting only that certain social mechanisms exist tending to increase real wages when output increases (for example, because the bargaining power of labor is increased), no statement is made about whether any resulting unemployment is voluntary or involuntary. Unemployment is then simply the difference between the actual amount of employment and the size of the labor force on some standard definition. From (15) and (16), the supply side of the model would then be: k(t)  a  r  w0  hy(t)

(17)

Profitability will fall if there is an increase in real interest rates, but rise if there is an increase in productivity. There is a negative relationship between output supply and profitability along this schedule, because if output increases real wages will increase also, and cut into the profit share. As the supply side is now specified in logs, we can also conveniently use a log-linear specification for demand: d(t)  x  bk(t  1),

b0

(18)

This says that realized current demand d(t) has an exogenous or autonomous component, x, and that it depends positively on currently realized profitability via the investment function. Because of the “marketing” lag, it is important to recall that d(t) is not the demand for current output y(t), but for the existing supply of goods and services y(t  1). Note that the combination of the explicit timing assumptions about production and sales, and also the underlying macroeconomic structure (involving endogenous money and credit creation), avoids tying current monetary demand too closely to the actual physical supply of output brought forward from the previous period. For example, consumption by workers is likely to depend on the current wage bill, which in turn depends on future sales expectations, rather than the wage bill received in the previous period. All these factors, and the contribution (e.g.) of fiscal policy, are impounded in the demand parameter, x. Dropping time subscripts and rearranging, the equilibrium schedules for a simple graphical treatment will be: y  (1/h)(a  r  w0)  [1/h]k

(19)

Aggregate demand and supply d  x  bk

123 (20)

Figure 7.8 illustrates these schedules, and also the case of a cheap money policy (lower real interest rates). When the monetary authorities set the interest at r1, for example, the level of output (read off the supply curve) will be y1, and this will be consistent with full equilibrium at point “a” where d  y1. The mark up k will also take a unique value at this point. Now suppose that the interest rate is reduced to r2. In the initial disequilibrium situation the actual level of employment, as mentioned, will be determined along the supply curve, and will be greater than previously. Hence, the initial situation will be one of excess supply. Subsequent shifts of both the demand and supply curve will be caused by changes in profitability, k, and the direction of such shifts can be inferred from equations (19) and (20). The final equilibrium position would then be at point “b”. The cheap money policy leads to a permanently higher level of output and employment, and a higher aggregate mark up. Now consider an increase in “autonomous demand” (that is, an increase in the parameter x), again starting from an equilibrium position, as shown in Figure 7.9. If output is determined along the supply curve, this will initially lead to a disequilibrium situation of excess demand, corresponding to the gap between the original supply curve and the new demand schedule. Subsequent market adjustment will bring about the new equilibrium. The final result will be higher levels r

AD

a

r1 b

r2

AS

y1

Figure 7.8 Changes in interest rates.

y2

y

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r

AD b

r1

a

AS

0

y1

y2

y

Figure 7.9 Changes in aggregate demand.

of output and employment, no change in the interest rate (unless the central bank takes deliberate action),6 and a fall in profitability. (This latter circumstance may well be the most sensible explanation of why “Keynesian economics” does not always command universal approval, even when it succeeds in reducing unemployment.) It will be useful finally to embed the above analysis in a graphical version that is a closer analogy to Keynes’s original presentation than Figures 7.8 and 7.9. This must involve a new diagram with the (log of) real aggregate demand and supply on the vertical axis, and the (log of) employment on the horizontal axis. The same analytical results as above must obviously continue to hold, so it suffices to consider just one example of an exogenous “shock,” namely an increase in the demand parameter, x. From (19), (20) and (13) the “z” and “d” functions will be: z  y  [1/(1  h)](k  r  w0)  [1/(1  h)]n

(21)

d  x  bk

(22)

This formulation stresses the point that demand is assumed to be essentially independent of the current momentary level of output on the supply side. It is just a sum of money, but not a fixed sum (as in the quantity theory of money) because of the possibility of endogenous credit creation. The demand (small d) function (a

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125

z,d

a

z

y2 d

y1 b

0

n1

n2

n

Figure 7.10 A change in aggregate demand in z,d space.

log-linear version of Keynes’s big D function) therefore shows up as a horizontal line rather than a positively sloped one. However, it still cuts the supply (small z) line (corresponding to Keynes’s big Z function) from above. Changes in demand therefore have the same ultimate effect as in the original Keynesian model. The main other differences from Keynes are that the endogenous mark-up/profit share is now a shift variable for both z and d functions, and also that the upward slope of the z curve is no longer due to any arbitrary assumption of wage rigidity. The equilibria are long run (permanent) situations, once attained. In Figure 7.10, the initial impact of an increase in autonomous demand is to shift the demand function vertically upwards, creating excess demand. As we have seen, the final adjustment involves a lower mark up, so there must be further shifts of both z and d functions before equilibrium is reached. Again, the final result is that the demand impulse leads to higher output and employment, albeit with a lower entrepreneurial profit share.

Conclusion The main policy lessons which might have been learnt from aggregative Keynesian economics are the importance of (a) a high level of effective demand and (b) low real rates of interest, for the healthy functioning of a capitalist economy. However, in spite of the best efforts of Ingrid Rima and others, Keynesian economics is now in eclipse. A main concern of orthodox economics for the past

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several decades has been to construct a theoretical apparatus that denies these propositions and asserts the opposite. Much of this process can be illustrated by the paths taken, or not taken, in the evolution of AD/AS analysis, as discussed in this chapter. The final section, however, constructed an alternative version of AD/AS, not dependent on nominal rigidities or other “short-run” devices, which nonetheless reinstates the original Keynesian results. In comparing this version of AD/AS analysis with the alternatives, note that it deals with the issue of whether the demand or supply is the proximate determinant of output by definitely asserting that it is the supply function (Keynes’s Z function) that embodies firms’ or entrepreneurs’ expectations. The principle of effective demand is nonetheless reinstated, by accepting the premise of Kaldor (1983), that macroeconomic price theory should be based on notions of imperfect rather than perfect competition. The aggregate mark-up/profit share can then be treated as an additional endogenous variable, providing the additional necessary degree of freedom. The model thus avoids the traditional criticism that demand effects can only occur in the short run and not the long run. The assumption of imperfect competition is not necessarily linked here with “increasing returns” (recall the assumption that a(t)  constant), but this is not meant to deny the potential importance of increasing returns empirically. Interest-rate changes affect supply in a diametrically opposed manner to the orthodox RBC model. An increase in interest rate is held to reduce (rather than increase) the amount of output supplied. Moreover, the interest rate is not subsumed by, or identified with, an imaginary marginal product of capital, a rate of time preference, or a rate of profit. It is simply the payment for a money loan. Amongst its other effects, therefore, an increase in the interest rate reduces or cuts into the entrepreneurial profit share, and vice versa for a reduction in the interest rate. The issue of the logical consistency of the AD/AS analysis is addressed in the first place by the identifying specifically the aggregate supply curve as the embodiment of firms’ expectations. Second, in an environment in which production takes time, and endogenous credit creation is important, a sharp distinction is made between “supply” in the sense of the actual goods and services available for sale at a point in time, and “demand,” meaning the real purchasing power in money available for expenditure. This may depend primarily on other factors than the most recent level of employment.7 Overall, the AD/AS model suggests that either a cheap money policy or a demand expansion with constant interest rates will tend to increase output and employment. The two types of policy initiatives, however, will have opposite effects on the entrepreneurial profit share. This last circumstance may be significant in explaining certain aspects of the political economy of the system.

Notes 1 See Smithin (2005) for a discussion of similar ideas in the context of growth economics. 2 Keynes (1936, p. 15), “(m)en are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate

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supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.” On the difference between Keynes’s and Kalecki’s approaches, see Davidson (2000). See also Atesoglu and Smithin (2005). For some recent evidence on this point for the G7 economies, see Atesoglu and Smithin (2004). As was stated explicitly by Keynes in the famous letter to Hicks of 31 March 1937 (Skidelsky, 1994, p. 614). However, there is clearly a definite longer run relationship between these two variables (with the reverse direction of causality).

References Atesoglu, H.S. and Smithin, J. (2004) Real wages, productivity and economic growth in the G7, 1960–2002. http://dept.econ.yorku.ca/~jsmithin/reseach.htm. Atesoglu, H.S. and Smithin, J. (2005) A simple macroeconomic model. http://dept. econ.yorku.ca/~jsmithin/reseach.htm. Barro, R.J. (1984) Macroeconomics (New York: John Wiley & Sons). Barro, R.J. (1994) The aggregate-supply/aggregate-demand model, Eastern Economic Journal, 20, pp. 1–6. Bhaduri, A., Laski, K., and Riese, M. (1995) Making sense of the aggregate demand and supply model. WIIW Working Paper 5, Vienna Institute for International Economics Studies. Bhaduri, A., Laski, K., and Riese, M (1999) Effective demand versus profit maximization in aggregate demand/supply analysis: a dynamic perspective, Banca Nazionale del Lavoro Quarterly Review, I-11, pp. 281–93. Burstein, M.L. (1995) Classical Macroeconomics for the Next Century (Toronto: York University). Chick, V. (1983) Macroeconomics After Keynes: A Reconsideration of the General Theory. (Cambridge, Massachusetts: MIT Press). Chick, V. (2000) Money and effective demand, in J. Smithin (ed.), What is Money? (London: Routledge), pp. 124–38. Colander, D. (1995) The stories we tell: a reconsideration of AD/AS analysis, Journal of Economic Perspectives, 9, pp. 169–88. Colander, D. (1997) Truth in labelling, AD/AS analysis, and pedagogy, Eastern Economic Journal, 23, pp. 477–82. Davidson, P. (1994) Post Keynesian Macroeconomic Theory (Aldershot: Edward Elgar). Davidson, P. (2000) There are major differences between Kalecki’s theory of employment and Keynes’s general theory of employment interest and money, Journal of Post Keynesian Economics, 23, pp. 3–25. Davidson, P. and Smolensky, E. (1964) Aggregate Supply and Demand Analysis (New York: Harper & Row). DeLong, J.B. (2002) Macroeconomics (New York: McGraw-Hill Irwin). Dutt, A.K. (1997) On an alleged inconsistency in aggregate-supply/aggregate-demand analysis, Eastern Economic Journal 23, pp. 469–76. Fields, T.W. and Hart, W.R. (1990) Some pitfalls in the conventional treatment of aggregate demand. Southern Economic Journal, 56, pp. 676–85. Fields, T.W. and Hart, W.R. (2003) Bridging the gap between the interest rate and price level approaches in the AD/AS model: the role of the loanable funds market, Eastern Economic Journal, 29, pp. 377–90.

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Hicks, J.R. (1937) Mr. Keynes and the Classics, Econometrica, 5, pp. 144–59. Kaldor, N. (1983) Keynesian economics after fifty years, in D. Worswick and J.R. Trevithick (eds), Keynes and the Modern World (Cambridge: Cambridge University Press), pp. 1–27. Kalecki, M. (1971) Selected Essays on the Dynamics of the Capitalist Economy 1933–1970 (Cambridge: Cambridge University Press). Keynes, J.M. (1930) A Treatise on Money, 2 vols (London: Macmillan). Keynes, J.M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). MacKinnon, K. and Smithin, J. (1993) An interest rate peg, inflation and output, Journal of Macroeconomics, 15, pp. 769–85. Mankiw, N.G. (1992) Macroeconomics (New York: Worth). Palley, T. (1996) Post Keynesian Economics (London: Macmillan). Palley, T. (1997) Expected aggregate demand, the production period, and the Keynesian theory of aggregate supply, The Manchester School, June, pp. 295–309. Patinkin, D. (1976) Keynes’s Monetary Thought: A Study of its Development (Durham, NC: Duke University Press). Patinkin, D. (1982) Anticipations of the General Theory? and Other Essays on Keynes (Chicago: University of Chicago Press). Rima, I.H. (1996) Development of Economic Analysis, 6th ed. (London: Routledge). Romer, D. (2000) Keynesian macroeconomics without the LM curve, Journal of Economic Perspectives, 14(2), pp. 149–70. Salant, W. (1985) Keynes and the modern world: a review article, Journal of Economic Literature, 23, pp. 1176–85. Skidelsky, R. (1994) John Maynard Keynes: The Economist as Saviour, 1920–1937 (New York: Penguin Press). Smithin, J. (1984) Medio and Musu’s Keynesian analysis of money wage changes: a comment, Economic Notes, 12(3), pp. 167–70. Smithin, J. (1985) On the definition of involuntary unemployment in Keynes’s General Theory: a note, History of Political Economy, 17, pp. 219–22. Smithin, J. (1986) The length of the production period and effective stabilization policy. Journal of Macroeconomics, 8, 1986, 55–62. Smithin, J. (1988) On flexible wage policy, Economies et Societies – Oeconomia, 22(3), pp. 135–53. Smithin, J. (1997) An alternative monetary model of inflation and growth, Review of Political Economy, 9, pp. 395–409. Smithin, J. (2002) Aggregate demand, effective demand, and aggregate supply in the open economy, in P. Arestis, M. Desai and S. Dow (eds), Money, Macroeconomics and Keynes: Essays in Honour of Victoria Chick, Vol 1. (London: Routledge), pp. 150–62. Smithin, J. (2005) The rate of interest, the business cycle, economic growth, and inflation: an alternative theoretical perspective. http://dept.econ.yorku.ca/~jsmithin/ reseach.htm. Snowden, B. (1997) To stabilize or not stabilize: is that the question?, in B. Snowden (ed.), Reflections on the Development of Modern Macroeconomics (Cheltenham: Edward Elgar), pp. 1–30. Taylor, J.B. (2000) Teaching modern macroeconomics at the principles level, American Economic Review, 90, pp. 90–94. Weintraub, S. (1961) Classical Keynesianism, Monetary Theory, and the Price Level (Philadelphia: Chilton).

8

Kaldor’s monetary thought A contribution to a modern theory of money* Claudio Sardoni

Introduction Nicholas Kaldor, one of the most representative Keynesian economists of the second half of the twentieth century, was always critical of some aspects of Keynes’s theory of money and, in particular, of his theory of the interest rate. In the 1980s, in expounding Keynes’s theory as opposed to the “old monetarism,” Kaldor was quite dismissive of Keynes’s innovations concerning the demand for money and the determination of the interest rate. Kaldor held that Keynes had added his theory of the interest rate to The General Theory (1936) as an “afterthought” because, once it was established that the equality between saving and investment is ensured by variation in the level of income, it was necessary to explain the interest rate in some way, so as not to leave it “in the air” (Kaldor, 1989).1 The analytical foundations of Kaldor’s position mentioned above can be found in his earlier work, more precisely in his 1939 article on speculation (Kaldor, 1939) and the appendix to it, which was published only in 1960 (Kaldor, 1960b). In these two works, Kaldor obtained “Keynesian results” but by following a different analytical path from Keynes’s in The General Theory. In the 1939 article, Kaldor offered an alternative to Keynes’s explanation of why the interest rate is not determined by the interaction of investment demand and the supply of saving. In the appendix, Kaldor showed that money “rules the roost” but for reasons different from those provided by Keynes. The innovations introduced by Kaldor may enable the Keynesian theory to deal more effectively with important features of modern monetary economies. The main object of this chapter is to present the salient aspects of Kaldor’s works, by emphasizing their innovative characteristics. The most important innovations introduced by Kaldor in dealing with monetary theory are the following. First of all, his analysis of speculation and its role in the determination of interest rates is carried out in a more complex and realistic analytical framework than that usually adopted by Keynesians and Keynes in The General Theory. Kaldor considered both spot and forward markets and made an explicit distinction between a short-term and a long-term interest rate. He analyzed the functional relationship between interest rates of securities of different maturities instead of taking the term-structure of interest rates as given.

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In developing his analysis of speculation, Kaldor abandoned the traditional Keynesian hypothesis that the alternative to speculative commitments is the holding of money (the speculative demand for money). In his analysis, when speculators want to be liquid they shift from the holding of long-term securities to the holding of shorter-term more liquid securities and not to money. In his analysis, Kaldor gives speculation an important role to play in the determination of interest rates, but without making use of the notion of the speculative demand for money, which instead is central in Keynes’s approach. In this sense, Kaldor’s analysis clearly is closer to the reality of modern financial markets, where the traditional speculative demand for money plays a minor role. Kaldor’s approach also makes it easier to relate the Keynesian tradition of thought to contemporary monetary theory, from which the speculative demand for money has virtually disappeared. In the appendix to his 1939 article, Kaldor provided an analytical explanation of why money rules the roost that is different from that offered by Keynes in chapter 17 of The General Theory. For Kaldor, the money rate of interest is critical in the determination of the aggregate level of the output, because money is the economy’s unit of account, or standard of value. Money matters not because of Keynes’s “essential properties,” which also other assets could have, but because it has the function of unit of account. Also in this sense, Kaldor’s approach establishes a bridge between the Keynesian tradition and contemporary debates on money and monetary policy. In particular, it is possible to establish an interesting relationship between Kaldor and those positions according to which the effectiveness of monetary policy ultimately depends on the fact that the central bank’s liability is the economy’s unit of account. The chapter is organized as follows. The next section discusses Kaldor’s 1939 article, concentrating on those aspects that are most relevant to monetary theory. The following section deals with Kaldor’s explanation of why money rules the roost. The concluding section assesses the capacity of the more innovative aspects of Kaldor’s work to deal with significant features of modern monetary economies and to offer a Keynesian contribution to contemporary debates in monetary theory.

“Speculation and economic stability”: Kaldor’s criticism of liquidity preference2 Kaldor held that his approach to speculation provided a more thorough and general explanation of basic features of market economies than Keynes’s theory of liquidity preference in The General Theory. Kaldor pointed out that his 1939 analysis “drew heavily” on Keynes’s Treatise on Money (1930), which was set in a more complex analytical framework than The General Theory.3 He set for himself the task of developing Keynes’s analysis by establishing a bridge between the Treatise and The General Theory. In retrospect, in 1960, Kaldor presented his article as an attempt to generalize Keynes on the basis of a general theory of speculation, i.e., a theory of the inter-

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play between flow demand and supply curves and stock demand and supply curves. For Kaldor, Keynes had tried to show that capital markets do not ensure the equality between saving and investment by using a model based on a “special case,” i.e., under special assumptions about the ability of speculation to stabilize prices (Kaldor, 1960a, p. 3). Kaldor studies the effects of speculation on both prices and output by considering spot and forward markets in which speculators, hedgers, and arbitrageurs operate. This chapter, however, looks only at the effects of speculation on prices and, in particular, on interest rates. Kaldor’s article can be divided into two parts: one dealing with the theory of speculation in general and the other concerned with the role of speculation in the determination of interest rates. The basic conditions for speculation to be possible are that the market is perfect (or nearly perfect) and the good or asset exchanged in it has a low net carrying cost (equal to “carrying cost proper” minus the asset’s yield). For any good, it is possible to define a normal level of stocks; stocks in excess of their normal level are speculative, i.e., held in the expectation of a price rise. In a world with little or no uncertainty, the difference between the current and expected price of an asset must be equal to the marginal interest cost4 plus the marginal carrying cost proper. If the difference were larger, speculation would eliminate it by making the current price rise because of a growing demand for the asset. If there is uncertainty, the expected price must be larger than the current price also by an additional amount that is the marginal risk premium, which is an increasing function of the degree of uncertainty (measured by the standard deviation of the probability distribution of prices) and the size of commitments, i.e., the size of speculative stocks (Kaldor, 1960c, p. 23).5 In symbols, EP  CP  i  c  q  r

(1)

where EP is the expected price, CP is the current price, i is the marginal interest cost, c is the marginal carrying cost proper, q is the marginal yield, and r is the marginal risk premium. Under a hypothesis of uniform expectations, arbitrage sets an upper limit to forward prices (FP) in relation to spot prices, while they have no lower limit (contango is constrained while backwardation is not). The upper limit derives from the fact that forward prices cannot be higher than current prices plus interest cost and net carrying cost, FP  CP  i  c  q

(2)

Therefore, from (1) and (2), FP  EP  r

(3)

Arbitrageurs ensure that FP does not rise above (EP  r). If FP  (EP  r), arbitrageurs would buy spot and sell forward, so that FP must decrease. On the other

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hand, speculators prevent FP from falling below (EP  r). In the case of uniform expectations, hedgers sell (buy) forward to (from) speculators only if the forward price of the security is larger (smaller) than its expected price net of the risk premium; i.e., hedgers sell if FP  (EP  r) or they buy if FP  (EP  r). But, on the other hand, speculators buy from hedgers only if FP  (EP  r) and they sell only if FP  (EP  r). Therefore, FP can never be different from EP  r. This is the theory of normal backwardation, which holds when expectations are uniform and only risk premia can differ among operators in the market. When the hypothesis of uniform expectations is lifted, speculators divide into “bulls” and “bears”; transactions take place not only between hedgers and speculators but also between bears and bulls. The bulls’ demand price is (EP  r), with both EP and r subjectively determined; the bears’ supply price is (EP  r) (with EP and r subjectively determined and different from the corresponding values for bulls). The price that tends to be established in the market is somewhere between (EP  r) and (EP  r), but it is not a simple average of these two values. In a market where bulls predominate, the forward price tends to exceed the expected price and vice versa when bears predominate. The effects of speculation on the prices of assets can be analyzed and discussed by using the notion of elasticity of speculative stocks (the rate of change of speculative stocks in relation to the rate of change of the ratio of the expected to the current price) and Hicks’s notion of elasticity of expectations (the reaction of expected variables to changes in their current values) (Hicks, 1939, p. 205). First of all, in order that changes in expected prices of assets have an effect on their current prices, the elasticity of speculative stocks must be positive. More precisely, the higher is the elasticity, the larger is the effect of expected prices on current prices.6 In general, speculation works in such a way as to reduce the amplitude of the fluctuations of current prices with respect to expected prices. In particular, if the expected price of an asset is given and constant, speculation would be fully stabilizing. To the contrary, speculation would be fully destabilizing either if the expected price of an asset changes more than proportionally with respect to changes in the current price or if the expected price changes independently of changes in the current price, for example due to speculative factors (Kaldor, 1960c, pp. 31–32). Kaldor concludes that if the elasticity of expectations is positive but less than one, speculation is still price stabilizing. Of course, speculation is fully stabilizing when the elasticity of expectations is zero. Thus, the elasticity of expectations and the elasticity of speculative stocks together determine to what extent and in which direction speculation affects prices.7 Kaldor, however, pointed out that it is difficult, if not impossible, to make precise and definite generalizations on the behavior of expectations. It is only possible to argue that expectations about the distant future are likely to be less elastic than expectations about the near future, and that expectations are less elastic the larger is the change in prices. By introducing a notion of normal price, Kaldor’s arguments can be expressed in the following terms. When price expectations are about the distant future, it is more likely that they are significantly influenced by the “normal

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price,” i.e., it is likely that agents expect that, in the long period, prices converge to their normal level. The larger is the deviation of the current price from its normal level, the longer is the time that speculators expect to elapse before the price returns to normality; in other words, small price changes are expected in the near future. These considerations lead to the conclusion that speculation is more likely to be destabilizing in the short period and when price fluctuations are small. Moreover, a market is more or less prone to speculation depending on whether the normal price plays a smaller or larger role. In markets where supply is highly elastic, the normal price plays an important role and speculation is essentially stabilizing (Kaldor, 1960c, pp. 34–35). At this juncture, we can turn to consider markets for securities. Many markets can be characterized by speculative behavior, but bonds and shares are the perfect objects for speculation. Kaldor concentrated on the bond markets. The bonds’ carrying cost proper is virtually nil whereas their yield is positive and invariant with respect to the size of speculation (Kaldor, 1960c, pp. 22–23). The analysis of speculation in the bond markets immediately raises a problem. In these markets, there is no real notion of a normal price but, at the same time, one observes that long-term rates are much more stable than short-term rates. Moreover, in this market the elasticity of speculative stocks is high, so that one has to conclude that the elasticity of expectations is very small.8 Kaldor saw the solution to the problem in the approach to the long-term interest rate suggested by Hicks, who considered the long-term interest rate as an average of forward short-term interest rates (Hicks, 1939, pp. 141–152).9 Let R1 be the current interest rate for a bond of maturity T, q1 the current short-term rate, and qi the forward short-term rate relative to period i (i  2, 3, . . ., T), with q  qie  ri, where qie and ri are the expected short-term rate and the risk premium relative to period i. It follows that T

(1  R1)T   (1  qi)

(4)

i1

If it is assumed that all the expected short-term rates are equal to the current one, because the latter is at its “normal” level (i.e., its long-term average value), the long-term interest rate of a bond of maturity T can be written as T

2 r R1  q1   T

(5)

where q1 is the current short-term rate and the second term denotes the series of risk premia embodied in forward rates q2 to qT (Kaldor, 1960b, pp. 64–68).10 It is then evident that, in this case, the long-term rate exceeds the short-term rate. In other words, the yield curve has its normal shape, i.e., it is upward sloping. Thus, the long-term rate of interest exceeds the normal short-term rate essentially for the same reasons as, in the case of commodities, the forward price is lower than the spot price. The difference between spot and forward values is given by normal backwardation.

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However, as we saw, the theory of normal backwardation holds only in the case of uniform expectations. Kaldor (1960b, p. 68) observed that “if there is sufficient divergence of expectations concerning future interest rates there is no longer any necessary reason to suppose that the long-term rate will be above the average of past short rates.”11 Thus, the conclusions concerning the long-term interest rate illustrated above cannot be regarded as universally valid. However, for Kaldor, the advantage of his approach was that it shows that, in any case, there is a complex relationship between the long- and the short-term interest rates, a relationship that Keynes did not consider in The General Theory.12 The long-term interest rate is influenced by changes in the current short-term rate only by a small proportion.13 In Kaldor’s analysis, moreover, the current short-term rate does not depend either on expected short rates or the long-term rate.14 The current short-term rate depends on the current demand for cash balances (for transaction purposes) and the current supply. In a footnote, Kaldor gave his explanation of why the short-term rate is not dependent on either the current or the expected long-term rate. Here Kaldor explicitly stated that speculators do not regard money as an alternative to their holdings of long-term securities: . . . a change in the long-term rate (either the current or the expected rate) cannot react back on the short-term rate except perhaps indirectly by causing a change in the level of income and, hence, in the demand for cash. For, supposing the change in the long rate causes speculators to sell longterm investments, this could only affect the short rate if they substituted the holding of cash for the holding of long-term bonds, it cannot affect the short rate if the substitution takes place in favour of short-term investment other than cash (savings deposits, etc.). But there is no reason to expect, in normal circumstances at any rate, that the substitution will be in favour of cash. “Idle balances” – i.e. that part of short-term holding which the owner does not require for transaction purposes – can be kept in forms such as savings deposits, which offer the same advantages as cash (as far as the preservation of capital value is concerned) and yield a return in addition. (Kaldor, 1960c, p. 39n; emphasis added)15 Since the elasticity of supply of cash with respect to the short-term rate is normally much larger than the elasticity of demand, the current short-term rate can be treated simply as a datum, determined by the policy of the central bank (Kaldor, 1960c, pp. 38–39). The analytical framework outlined above leads, for Kaldor, to the same conclusion as Keynes’s with respect to the role of saving and investment in the determination of the rate of interest. In the short period, saving and investment do not determine the long-term interest rate, but “the insensitiveness of the longterm rate to ‘outside’ influences (i.e. the supply and demand for ‘saving’) is not due to any ‘liquidity premium’ attached to money or short-term bills” (Kaldor, 1960c, p. 40).

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In Keynes’s analysis, a liquidity premium is attached to money because there is uncertainty about future interest rates, but Kaldor showed that this is not correct. In Kaldor’s analysis, if there is no uncertainty (and, hence, r  0), the long-term interest rate would depend entirely on expectations.16 If such expectations are given, the long-term rate would be uniquely determined and independent of changes in saving and investment. Put in terms of Keynes’s analysis, this would paradoxically mean that, in situations of no uncertainty the liquidity premium should be infinite.17 Therefore, for Kaldor, it is not . . . so much the uncertainty concerning future interest rates as the inelasticity of interest expectations which is responsible for Mr. Keynes’ “liquidity preference function” (. . .). The uncertainty of expectations works rather in the opposite direction. For when uncertainty is high not only is the amount of the marginal risk premium high, but the elasticity of the marginal risk premium curve (and hence the elasticity of speculative stocks) is low; speculators are much less willing to extend their commitments or to reduce them. It is in such periods that variations in the “outside” demand or supply can be expected to have the most marked effect on bond prices. (Kaldor, 1960c, p. 41) Kaldor elaborated further on his criticism of Keynes’s analysis. It is not correct to say that the long-term rate is determined by supply of long-term assets and the demand for liquid funds (money  bills). In reality, the interest rate brings to equality demand and supply of money only if one refers to the short-term rate and money denotes only what is used as a means of exchange. When one looks at the long-term rate, what has to be considered is not the speculators’ demand for liquid funds but their supply of long-term assets. What is relevant for the determination of the long-term rate is the speculators’ willingness to undertake particular commitments rather than their “preference for avoiding commitments in general (i.e. their preference for ‘liquidity’)” (Kaldor 1960c, pp. 41–42). Kaldor’s conclusion, then, is that the market for long-term bonds is characterized by a small elasticity of expectations and a high elasticity of speculative stocks, both absolutely and relatively to the elasticity of the non-speculative demand and supply (i.e., the firms’ demand for long-term loans to finance investment and savings). Therefore, in the short run, the long-term interest rate is essentially determined by speculative factors, i.e., changes in the supply and demand for stocks, even though it would be incorrect to say that savings and investment have no effect at all on the rate of interest. Their influence on the interest rate is “largely overshadowed” by the influence exerted by speculative factors. Kaldor concluded this part of his article with some considerations on the market for shares, which is more unstable than the bond market. His basic point was that, although the price of shares – like the price of bonds – is influenced by the expectations about interest rates, it also depends on expectations concerning future profits, which are very elastic for several reasons. First, since firms’ profits are likely to have a trend, the formation of expectations about their

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long-run normal level may be impossible. Second, because of high uncertainty about the distant future, profits relative to distant periods are heavily discounted and profits relative to the near future are given a larger weight than would follow from discounting at compound interest. Finally, because short-period price fluctuations are large, market operators concentrate on the short-period expectations about the capital value of firms rather than on their long-term prospects. Therefore, “speculative motives get inseparably mixed up with other motives and it is no longer possible to distinguish between speculative demand and non-speculative demand. It is in such circumstances that the destabilizing influence of speculation will dominate over a wide range of price oscillation” (Kaldor, 1960c, pp. 43–44).

The crucial role of money as unit of account The appendix to Kaldor’s 1939 article was published only in 1960 as a chapter of his Essays on Economic Stability and Growth. It is concerned with the ownrates of interest, which are analyzed differently from Keynes’s treatment of the topic in chapter 17 of The General Theory. For Keynes (1936), money “rules the roost” in the sense that the interest on it sets a limit to the level of employment that the economy can realize. It is so because the interest rate on money is the most reluctant to decline as the stocks of all assets increase. Since the yield of assets is a decreasing function of their quantity,18 the equilibrium quantity of all assets is determined by the asset yield that is fixed or highly sticky: the production of all the other assets will not be pushed beyond the level at which their yield equals the “sticky yield.” What is not obvious, however, is why money plays such a crucial role. In Keynes’s analysis, the own-rate of own-interest of an asset is defined as Rio  qi  ci  li (i  1, 2, . . ., n) where qi is the yield of the i-th asset in terms of itself, ci is the i-th asset’s carrying cost and li is its liquidity premium, which is the amount of the asset itself that an agent is willing to pay for the potential convenience of the power of disposal of the asset. Money (the m-th asset) is characterized by the following properties: qm  0; cm  0; lm  lm  0 Money is a non-producible asset (it has a zero elasticity of production) and the yield in terms of itself is nil. Money has also a nil carrying cost. Finally, money has a positive and constant liquidity premium (it has a zero elasticity of substitution). Therefore, Rom  lm

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In equilibrium, it must be Rom  Rio (i  1, 2, . . ., n; i  m) which means that money “rules the roost”: its interest rate determines the equilibrium quantities of all the other assets. The notion of money used above corresponds to money “as we know it,” that is to say money as standard of value, medium of exchange, and store of value. For Keynes, however, the role of money could be played by any other asset, which is not the standard of value but has all the other properties of money. Other assets, like land, may have played the same role as money in some historic situations (Keynes, 1936, p. 241). Although Keynes acknowledged the importance of the function of money as the standard of value,19 this function was not a sufficient condition for it to rule the roost. Kaldor’s criticism of Keynes’s analysis concentrates on the view that other assets than the one which is the unit of account can rule the roost. Kaldor focused on the own-rates of money-interest of the assets, that is to say the ownrate of own-interest corrected by the assets’ appreciation or depreciation in terms of money, which had already been introduced by Keynes. The i-th asset’s ownrate of money-interest is Ri  ai  qi  ci  ri (i  1, 2, . . ., n)

(6)

where ai is the appreciation or depreciation of the i-th asset in terms of money, qi is the yield of the i-th asset in terms of itself, ci is the i-th asset’s carrying cost; ri is the i-th asset’s marginal risk premium, which is defined as a deduction from “the yield of those assets which, on account of the uncertainty of future value (or return) in terms of money, or on account of their marketability, carry a risk premium for which this yield must compensate” (Kaldor, 1960b, p. 60). Kaldor uses the notion of marginal risk premium (r) instead of the liquidity premium (l). The main reason Kaldor prefers to use r is that by using r instead of l it is possible to draw a clear-cut distinction between the liquidity and the “convenience yield” of money. The convenience yield of money derives from the fact that exchanges are made in money and, hence, it is convenient to hold a certain amount of it.20 Instead, using Keynes’s method, the two attributes of money become inseparable, although liquidity is comparative while convenience is not (Kaldor, 1960b, p. 61). If there exist n assets in the economy, the equilibrium is realized when the assets’ own-rates of money-interest are equal, i.e. Ri  ai  qi  ci  ri  Rj  aj  qj  cj  rj (i, j  1, 2, . . ., n; i  j)

(7)

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As to money (the m-th asset), it is the economy’s standard of value and cannot appreciate or depreciate in terms of itself (am  0). Moreover, as there is no uncertainty about its future value and it is perfectly marketable, money has a nil marginal risk premium (rm  0). The money’s carrying cost is negligible and, for simplicity, it can be considered as nil (cm  0). The yield of money in terms of itself, qm, is its convenience yield. Thus, Rm  qm

(8)

The nearest substitute for money is short-term bills (the b-th asset). They have a small risk premium (fairly insensitive to their quantity); their carrying cost can be assumed to be nil. Finally, short-term bills have also a negligible or nil expected price change. Therefore, Rb  qb  rb

(9)

In equilibrium, it must be Rm  Rb, that is to say qm  qb  rb

(10)

rb sets the lower limit to the bill-rate of interest. When the marginal convenience yield of money, qm, falls to zero,21 the bill-own rate of interest (qb) reduces to rb. At this juncture, Kaldor reconsiders the determination of the long-term interest rate and, with some assumptions, arrives at the formulation seen in above. Now, from (10) it is clear the relationship between the long-term interest rate and the yield of money. The long-term rate depends on the convenience yield of money, which affects the current short rate, and the whole structure of risk premia. We can now turn to the discussion of why money rules the roost. If it is assumed that the expected price of reproducible assets is given by their longperiod supply prices (their normal prices), an asset is produced only when its current price is higher than its supply price, i.e., when a is positive. When, for an asset, a  0, its current price is equal to its expected price (its normal price) and, hence, the marginal efficiency of the asset,22 its own-rate of own-interest and its own-rate of money-interest are all equal. In this framework, the general level of the own-rates of money-interest is set by the greatest of the own-rates of own-interest among those assets whose ownrate of money-interest (Ri) cannot vary with respect to their own-rate of owninterest (qi  ci  ri). The only asset with such a characteristic is money because it is the standard of value and, hence, am  0: “all assets other than money can adjust their own-rates of money-interest to that of money by a variation of their current price in terms of money; while the money-rate of money-interest can only be changed by varying money’s own-rate of own-interest” (Kaldor, 1960b, p. 70). The current money-rate of money-interest rate can change only if the current

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money’s own-rate of own-interest changes. This, for Kaldor, could happen if the stock of money in circulation changes and affects qm. However, provided that the change in the current money’s own-rate of own-interest does not affect its expected future values, the impact on the long-term interest rate is little. In fact, the long-term rate is an average of the current qm, the expected future values of qm and risk premia. Moreover, in Kaldor’s analysis it is the central bank that ensures that qm, and hence qb, does not change or, more precisely, it is the central bank that controls the short-term interest rate. From this analysis it follows that if there existed an asset other than money whose yield is sticky with respect to its level of production, it could not play the same role as money (the standard of value). The price in terms of money of such an asset, in fact, would increase and, consequently, its own money-interest rate would fall relatively to its own rate of own-interest and “thereby lower the standard to which the own-rates of interest of other assets must conform” (Kaldor, 1960b, p. 71). The analysis above was conducted by taking the assets’ long-period supply prices as their expected prices, which amounts to assume that price expectations are inelastic. The picture changes if expectations are assumed to be elastic. In this case, when the current price of an asset rises, its expected price rises as well, so that the asset’s rate of money-interest does not necessarily decrease with respect to its own-rate of own-interest. However, the increase in the asset’s money price would reduce its own-rate of own-interest: if the asset’s yield is fixed in money terms, the increase in its price reduces its yield in terms of itself. The exception is when there is an asset whose yield is fixed in terms of itself. Such a case, however, for Kaldor is very unlikely. Moreover, to assume that an asset’s yield is fixed in terms of itself basically amounts to assuming that such asset is the economy’s standard of value. Thus, Kaldor’s general conclusion is that money rules the roost because it is the asset whose “price” cannot vary. Therefore, “the kind of liquidity preference which is capable of setting a limit to the level of employment is inherently associated with the commodity which serves as the unit of account, and cannot reside in an asset other than money” (Kaldor, 1960b, pp. 73–74). The money interest rate cannot become negative and this sets a limit to the profitable production of real assets and, hence, employment.

Kaldor’s innovations in the theory of money and speculation Kaldor carried out his analysis of speculation and interest rates in a more complex framework than in The General Theory and in other subsequent Keynesian works, but the originality and novelty of his contributions are not simply due to this. In fact, despite the simplifications in The General Theory, Keynes was well aware of the complexity and sophistication of modern financial markets.23 The innovative character of Kaldor’s works lies in his ability to combine the analytical elements mentioned above in such a way as to develop Keynes’s theory by reaching important Keynesian results through a different,

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and analytically more satisfactory, path. The approach followed by Kaldor also has the merit of being more suitable for dealing with some features of modern monetary economies. In Kaldor’s analysis, as in Keynes’s, speculation plays an important role in the explanation of why the interest rate is not the variable that equates saving and investment. But Kaldor, differently from Keynes, abandoned the hypothesis that speculators regard the holding of money as the alternative to the holding of speculative stocks of long-term securities. From this point of view, Kaldor brings Keynesian analysis closer to the reality of modern financial markets, where the speculative demand for money plays a lesser, if any, role. In fact, in contemporary macroeconomics, the speculative demand for money has virtually disappeared.24 This may be partly due to the definitive departure of much contemporary mainstream macroeconomics from its Keynesian origins, but it also because the speculative demand for money is commonly seen as an obsolete notion in the context of modern developed economies. Innovation has produced complex and sophisticated monetary and financial markets, in which there exist several instruments that are as liquid and riskless as money.25 Therefore, there are no longer rational reasons to demand money as an alternative to less liquid and riskier assets. As a consequence, money is no longer demanded for reasons other than the transactions and precautionary motives.26 Unfortunately the line followed by Kaldor has not been taken up by most Keynesians. Two eminent Keynesian economists, Joan Robinson and Richard Kahn, in their efforts to develop Keynes’s theory of money beyond the state in which he left it, nevertheless maintained the hypothesis that speculators demand idle money as the alternative to their speculative holdings of securities. Robinson (1951) regarded Keynes’s theory of the interest rate based on the demand and supply of money as a simplification; but in developing her own theory, she retained the hypothesis that speculators demand idle money.27 A few years later, Kahn (1954, pp. 79–80), in dealing with the distinction between the precautionary and the speculative demand for money, made similar hypotheses about speculation and conducted his analysis by considering only the demand for longterm securities and the demand for money. Both Robinson and Kahn were critical of Kaldor’s approach in general and, in particular, of his theory of the long-term interest rate. It is worth considering some aspects of these criticisms as it underscores the innovative character of Kaldor’s analysis. Robinson (1951, p. 152n) argued as follows: The view that the long rate can be determined solely from expectations about the short rate is untenable. It is true, in a world in which expectations are definite and unanimous, that when we know today’s bond rate and today’s bill rate, we can reckon what change in the price of bonds is expected over the life of the bills. Then, looking into a further future, we can assume that the bill rate then expected to rule is known, and that by then the expected price of bonds is expected to obtain. Then we can reckon the

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expected change in bond prices over the further future, and so on to the Kingdom Come. Then the whole pattern of expectations could be described in terms of the expected short rates alone. But all this means is that rational expectations must be self-consistent. It certainly does not detach the rate of interest from dependence on its boot straps for, in such a world, the only reason for a difference between short and long term rates is the expectation of a change in the long rate. Indeed, one might say that there the short rate is simply an expression of expectations about bond prices.28 Robinson fails to perceive important aspects of Kaldor’s and Hicks’s theory. First of all, she overlooks that both in Hicks’s and Kaldor’s analyses the longterm rate does not merely depend on expected short-term rates. The long-term rate is an average of the current short-term rate and the forward short-term rates. In other words, Robinson did not take into any account the existence of forward markets. Second, it is not correct to argue that the short-term rate might depend on the expected long-term rate. In Kaldor’s analysis, as we saw, the short-term rate is independent of expectations and determined by the central bank. Robinson is right, however, to point out that Kaldor’s theory holds on the grounds of a hypothesis of uniform expectations. But Kaldor himself is aware of this limitation. Nonetheless, even when the hypothesis of uniform expectations is lifted, it remains true that the relationship between the long- and short-term rates is not simply explained by expectations but also by the working of markets, which include forward markets. Kaldor’s approach to the long-term interest rate and its relation to the shortterm rate certainly is closer to contemporary monetary theory, which is largely based on the idea that the yield curve is explained by the interplay of the factors that appear in Kaldor’s analysis, that is to say organized financial markets, risk premia, and monetary policy. But Kaldor’s position concerning the relative stability of the long-term rate is significant also in dealing with another issue that has interested Keynesian economists; that is the problem of the functional dependence of investment on the interest rate, which has never had strong empirical support. Kalecki, who adopted the same theory of the long-term interest rate as Kaldor, refers to it to show why the interest rate cannot be used to explain the business cycle: “in view of the fact that the long-term rate of interest (. . .) does not show marked cyclical fluctuations, it can hardly be considered an important element in the mechanism of the business cycle” (Kalecki, 1965, p. 88). For this reason, the long-term rate is not one of the arguments of his investment function, which is at the core of the theory of the cycle (Kalecki, 1965, pp. 96–108). Robinson’s and Kahn’s positions, however, prevailed and most Keynesians have followed their approach and ignored Kaldor’s theory of speculation and interest rates. It might seem, however, that the differences between Kaldor and other Keynesians are less significant than it appears. This sort of “reconciliation” might find its inspiration in Keynes’s definition of money in The General Theory.

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In Kaldor’s analysis, the definition of money and its functions is straightforward. Money is the economy’s standard of value and its medium of exchange; money does not play any significant role as a store of value. Therefore liquidity preference cannot play the same role as in Keynes. Changes in the speculators’ expectations do not imply changes in their demand for money and, hence, in the interest rate in the way they do in The General Theory. Also in Kaldor’s analysis, however, speculators who do not want to hold speculative stocks demand more liquid assets, which for simplicity can be called “bills.” For Keynes, money is a “vague” notion, in the sense that we can define money differently according to the analytical needs, so that “we can draw the line between ‘money’ and ‘debts’ at whatever point is most convenient for handling a particular problem” (Keynes, 1936, p. 167n). Given a set of assets of varying liquidity, the subset of highly liquid assets can have different dimensions. In this context, therefore, to say that speculators demand money does not necessarily mean that they hold cash or demand deposits (M1 in modern parlance). In this sense, Kaldor’s views on speculation could be reduced to Keynes’s original position: the speculators’ demand for liquid assets might be called “demand for money.” Such a solution to the issues set by Kaldor, however, is more apparent than real. The assets contained in the “liquid subset” do not have all the same attributes. More precisely, not all the liquid assets can function as unit of account or means of payment: short-term securities (bills) are highly liquid but they are not used either as a unit of account or as a medium of exchange. If the analysis focuses on the problem of liquidity, Keynes’s “vague” definition of money could be acceptable, but it is unsatisfactory when the other functions of money are also considered. Keynes, at least in The General Theory, tended to downplay the importance of the role of money as standard of value; therefore he could easily extend the definition of money to other liquid assets. For Kaldor, instead, money rules the roost precisely because it is the standard of value; therefore the notion of demand for money cannot be extended to other assets than the instrument that is the economy’s unit of account. Kaldor’s insistence on the crucial role of money as the economy’s standard of value brings his approach significantly close to a recent debate on central banking and monetary policy. In arguing that central banks can implement effective monetary policies also in economies in which the demand for money and, in particular, base money has declined significantly, Michael Woodford (2000, 2001, 2002, 2003) has argued that the central bank ultimately derives this ability from the fact that its liability is the economy’s unit of account. Woodford finds his inspiration in the Wicksellian tradition, but consideration of Kaldor’s contributions shows that an inspiration for this sort of position can be found in the Keynesian tradition as well,29 provided that the role of money as the economy’s unit of account is emphasized rather than other properties, which tend to become less significant in modern monetary economies.

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Notes * A previous version of this chapter was presented at the 2nd STOREP conference (Siena, June 2–4, 2005). I would like to thank M. Franzini, the discussant, and the other participants for their helpful comments. I also wish to thank J. Bibow and G. Harcourt for their suggestions and comments on earlier versions of the paper. Any remaining errors are, of course, my sole responsibility. 1 Kaldor also pointed out that Keynes himself, after The General Theory, had underrated his own theory of the interest rate (see Keynes, 1937). 2 This chapter considers a revised version of Kaldor’s original 1939 article. This version, published in 1960 (Kaldor, 1960a), is the result of Kaldor’s response to some criticisms of his original article made by Dow and Hawtrey. The discussion between Kaldor, Hawtrey, and Dow was mainly centered on the issue of the determination of forward prices; see Dow (1940a, 1940b), Hawtrey (1940), Kaldor (1940, 1960a, p. 4), and also Tsiang (1989, pp. 20, 44n). Kaldor’s article is generally regarded as one of his most important theoretical contributions. In 1986, Hicks wrote to Kaldor: “I think that your paper was the culmination of the Keynesian revolution in theory” (quoted in Thirlwall, 1987, p. 75n). Kaldor’s article deals with several theoretical and analytical issues. This chapter, however, looks only at those aspects that are relevant to the theory of money and interest rates. 3 For Kaldor, in The General Theory, “Keynes invented some short-cuts through the maze of complications of a multi-market analysis and thereby reduced the essential aspects of the problem to manageable dimensions” (Kaldor, 1960a, pp. 3–4). 4 The relevant interest rate is the short-term rate because speculation essentially is a short-period phenomenon. 5 Dow (1940b, p. 188) pointed out that Kaldor’s definition of risk premium is an application of Kalecki’s principle of increasing risk. 6 If the elasticity of speculative stocks were infinite, current prices would depend only on expected prices. 7 The influence of speculation on prices can be expressed as  e(  1) (e is the elasticity of speculative stocks and is the elasticity of expectations). 8 This phenomenon could be explained by arguing that the expected price is determined by an average of past prices, so that the longer is the past period considered, the less sensitive is the expected price to current variations. But such explanation is subject to Robertson’s “bootstrap critique” (1966, pp. 150–187): if the current price of longterm bonds is determined by the expected price and the latter depends on past prices, how were those past prices determined? 9 If there is a long-term loan market, there must be a series of forward markets in shortterm loans. Forward short-term rates depend on expected short-term rates and risk premia. 10 This formulation of the long-term interest rate was presented by Kaldor in the appendix to the article. The notation adopted here is partially different from the one used by Kaldor. 11 The yield curve can be either downward sloping or flat. 12 “This is not a problem which Keynes anywhere considers explicitly, but one which can be analysed in terms that are perfectly consistent (in our view) with his general approach” (Kaldor, 1960a, pp. 68–69). 13 The current long-term rate can be also seen as determined by expected long-term rates, but this amounts to the same as seeing the current rate as the average of expected short-term rates. If R2 is the expected long-term rate in the next period of a T

bond

of

maturity

T,

it

is

(1  R2)T1   (1  qi). i2

Therefore,

from

(4),

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(1  R1)T (1  R2)T1   . The expected long-term rate, R2, for the next period is larger (1  q1)

14 15

16 17 18 19 20

21 22 23 24

25

26

27

(smaller) than the current long-term rate (R1) only if the current short-term rate (q1) is smaller (larger) than its expected average over the T periods. Expected short rates do not affect the current short rate because the duration of shortterm bills is too short for expectations to be relevant (Kaldor, 1960c, p. 39n). Kaldor made this point clearer later on in his 1960 introduction to Essays on Economic Stability and Growth: “A net shift from bonds to bills by the ‘speculators’ assumes an opposite shift from bills to bonds by either the ‘non-speculators’ or the banking system, and in either case the bill rate will remain unaffected if the quantity of money and the level of income are taken as given” (Kaldor 1960a, pp. 4–5n). Kaldor was replying to a criticism from Robertson (1952), who had argued that speculation must affect also the short-term interest rate. See also Kennedy (1948–49). The long-term rate would be the average of expected short-term rates. For this reason, Kaldor (1960c, p. 40) argued that his notion of risk premium could not be interpreted as merely the negative of Keynes’s liquidity premium. This is Keynes’s hypothesis of a decreasing marginal efficiency of capital. See also Keynes (1930, pp. 3–5), where he emphasize the primary importance of money as the economy’s unit of account. The convenience yield of money is similar to the “convenience yield of wheat to the miller or stocks of cotton to the yarn-maker.” The convenience yield of money depends on the ratio of the money stock to the volume of money payments. It falls to zero when the ratio exceeds a certain critical value (Kaldor, 1960b, pp. 61–62). Because the amount of money in circulation exceeds its critical level (see note 20). The marginal efficiency of an asset is defined by Kaldor as the relationship of its future return to its present cost of production, i.e., its long-period supply price (Kaldor, 1960b, p. 59). As early as in the 1920s, in A Tract on Monetary Reform (1923), Keynes was one of the first economists to deal with forward markets. In previous standard textbooks, the speculative demand for money was commonly treated by using Tobin’s well-known model (Tobin, 1958), in which the demand for money as a store of value is explained as the outcome of a process of agents’ utility maximization through the choice of their optimal portfolios of assets. Chang et al. (1983, pp. 421–422), for example, state that “if money market instruments are explicitly incorporated in a portfolio model, the demand for money as a buffer against interest risk vanishes.” More recently, Handa (2000, p. 121) has expressed the same viewpoint: “in economies with a variety of riskless assets (. . .) the speculative demand for M1 (. . .) would be non-existent or confined to those individuals who do not have access to other riskless assets at a low enough cost.” Models based on the speculative demand for money are not “applicable to the M1 holdings of the common households, firms and financial institutions in the modern developed economy. In such a context, while there may be a significant and large speculative demand for certain savings deposits and for money market instruments, there need not be a significant one for currency and demand deposits.” Blanchard and Fisher (1993, p. 154) hold that money as a store of value is dominated by many other assets. An inverse functional relation between the interest rate and the demand for money is maintained by making the transactions and precautionary demand also depend on the rate of interest. As is well known, Baumol (1952) and Tobin (1956) originated this type of approach to the demand for money as a medium of exchange. Money is partly demanded for the transactions motive (active circulation), a part is hoarded short and another part is hoarded long. It is so because “it has come into the hands of owners who choose to hold a part of their wealth in the form of money” and

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because there are “bear hoards,” “whose owners are waiting for a fall in bond or share prices to go back into the market” (Robinson, 1951, p. 149). In particular, Robinson argued, “it is natural to assume that, in the main, money is preferred to bills for long hoards because dealing in bills is a specialised business, for which money owners of long hoards have no inclination, and because it is not practicable in small terms” (1951, p. 150). 28 For Kahn’s criticisms, see Kahn (1954, pp. 75–78). 29 For a more detailed discussion of the recent debate on central banking in relation to Kaldor’s position, see Sardoni (2004).

References Baumol, W. J. (1952) “The Transactions Demand for Cash: An Inventory Theoretic Approach,” Quarterly Journal of Economics, 56, pp. 545–556. Blanchard, O. J. and Fischer, S. (1993) Lectures on Macroeconomics (Cambridge, MA: MIT Press). Chang, W. W., Hamberg, D., and Hirata, J. (1983) “Liquidity Preference as Behavior toward Risk Is a Demand for Short-Term Securities – Not Money,” American Economic Review, 73, pp. 420–427. Dow, J. C. R. (1940a) “Addenda to Mr. Kaldor’s Note, “ Review of Economic Studies, 7, pp. 201–202. Dow, J. C. R. (1940b) “A Theoretical Account of Futures Markets,” Review of Economic Studies, 7, pp. 185–195. Handa, J. (2000) Monetary Economics (London: Routledge). Hawtrey, R. G. (1940) “Mr. Kaldor on the Forward Market,” Review of Economic Studies, 7, pp. 202–205. Hicks, J. R. (1939) Value and Capital: An Inquiry into Some Fundamental Principles of Economic Theory (London: Oxford University Press). Kahn, R. F. (1954) “Some Notes on Liquidity Preference,” Manchester School of Economic and Social Studies, 22, pp. 229–257. Kaldor, N. (1939) “Speculation and Economic Stability,” Review of Economic Studies, 7, pp. 1–27. Kaldor, N. (1940) “A Note on the Theory of the Forward Market,” Review of Economic Studies, 7, pp. 196–201. Kaldor, N. (1960a) Essays on Economic Stability and Growth. Collected Economic Essays by Nicholas Kaldor (London: Duckworth). Kaldor, N. (1960b) “Keynes’ Theory of the Own-Rates of Interest,” in Essays on Economic Stability and Growth. Collected Economic Essays by Nicholas Kaldor (London: Duckworth). Kaldor, N. (1960c) “Speculation and Economic Stability,” in Essays on Economic Stability and Growth. Collected Economic Essays by Nicholas Kaldor (London: Duckworth). Kaldor, N. (1989) “Origins of the New Monetarism,” in Further Essays on Economic Theory and Policy. Collected Economic Essays by Nicholas Kaldor (New York: Holmes & Meyer). Kalecki, M. (1965) Theory of Economic Dynamics, second edition (London: Allen & Unwin). Kennedy, C. (1948–49) “Period Analysis and the Demand for Money,” Review of Economic Studies, 16, pp. 41–49.

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Keynes, J. M. (1923) A Tract on Monetary Reform (London: Macmillan). Keynes, J. M. (1930) A Treatise on Money (London: Macmillan). Keynes, J. M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). Keynes, J. M. (1937) “Alternative Theories of the Rate of Interest,” Economic Journal, 47, pp. 241–252 Robertson, D. H. (1952) “Some Notes on the Theory of Interest,” in Utility and All That (London: George Allen & Unwin). Robertson, D. H. (1966) Essays in Money and Interest (London: Fontana Books). Robinson, J. V. (1951) “The Rate of Interest,” Econometrica, 19, pp. 92–111. Sardoni, C. (2004) “Why Do Central Banks (and Money) Rule the Roost?,” Central Banking and the Financial System, Vol. II (Warsaw: National Bank of Poland). Thirlwall, A. P. (1987) Nicholas Kaldor (Brighton: Wheatsheaf). Tobin, J. (1956) “The Interest-Elasticity of Transactions Demand for Cash,” Review of Economics and Statistics, 38, pp. 241–247. Tobin, J. (1958) “Liquidity Preference as Behavior Towards Risk,” Review of Economic Studies, 25, pp. 65–86. Tsiang, S. C. (1989) Finance Constraints and the Theory of Money. Selected Papers (New York: Academic Press). Woodford, M. (2000) “Monetary Policy in a World without Money,” International Finance, 2, pp. 229–260. Woodford, M. (2001) “Monetary Policy in the Information Economy,” in Economic Policy for the Information Economy (Kansas City: Federal Reserve Bank of Kansas City). Woodford, M. (2002) “Financial Market Efficiency and the Effectiveness of Monetary Policy,” Economic Policy Review, Federal Reserve Bank of New York, 8: 1, pp. 85–94. Woodford, M. (2003) Interest & Prices. Foundations of a Theory of Monetary Policy (Princeton: Princeton University Press).

9

The political economy of John Kenneth Galbraith An interpretation Warren J. Samuels

The death of John Kenneth Galbraith on April 30, 2006 and the earlier publication of Richard Parker’s heavily researched and deeply analyzed John Kenneth Galbraith: His Life, His Politics, His Economics (2005) warrant a meditation on Galbraith’s contributions to economics, especially one published in honor of one of his admirers, Ingrid Rima. Galbraith’s emphases on power, class, hypocrisy in business and politics, full employment in the production of meaningful goods, and so on, are presented. So too are his careers in government and in academia as well as his wide-ranging and, for most observers, largely behind-the-scenes activities in Democratic politics. He was not only, in part, a Keynesian; he was the American John Maynard Keynes in the range, depth, and activism of his life’s work. Parker carefully examines Galbraith’s major writings, especially American Capitalism (1952), The Affluent Society (1958), The New Industrial State (1967), Economics and the Public Purpose (1973), The Anatomy of Power (1983), and The Culture of Contentment (1992). While he states important generalizations in one or more sentences, he does not present a generalized overview. The basic political economy of John Kenneth Galbraith was more than a summary of the leading specific themes of each of his major works; concentrating on those specific themes is important but may obscure the larger picture. The basic Galbraith resides in the transcendent paradigm given numerous partial, if important, expressions in his individual works. That Parker does not provide this overall view is indicated by the omission of entries in the book’s index on Galbraith’s major paradigmatic themes. There are no entries on liberalism and conservatism. Although one gets their general messages from Parker’s account of Galbraith’s career, they remain largely primitive terms. More importantly, no entries are to be found on class, ideology, government, market, social choice, political (or politics), power, or public purpose. The peculiar omission of an entry on power misses Galbraith’s general legal-economic or political-economic theory, where power is central. Power, it should be noted, is not used here in a pejorative sense. By power is meant participation in decision-making and the bases thereof, such as legal rights. The objective of this chapter is to present an overview of the deepest themes of Galbraith’s political economics. The next section examines Galbraith’s

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political economy, including his emphasis on multiple systems of social control and valuation, democracy and the growth of government, governmental activism, and the interdependence of economic and political power. The following section considers the problem of the modern liberal. This is followed by sections further examining power, and exploring Galbraith the theorist of power and the practitioner of power. The conclusion partly sums up the interpretation and partly treats several further topics. My analysis relies upon and deploys many of Parker’s points in order to give him his just due, which is considerable. Several sections consider some important difficulties with Galbraith’s ideas.

Galbraith’s political economy Galbraith rejected several premises of mainstream neoclassical economics. One was the assumption that the economy exists independent of government and other institutions. As between the model of the market in pure abstract a-institutional conceptual terms and that of the market as a result of the institutions, especially government, which form and operate through the market, Galbraith opted for the latter. Conclusions drawn from the former type of model cannot be applied to actual economies without further analysis of the relevant institutions; asserting the conditions necessary to achieve either equilibrium or optimal solutions, given the non-unique nature of equilibrium optimal results, accomplishes very little or nothing about actual economies. Galbraith, like Gardiner Means and, oddly enough, Ronald Coase, understood that large firms could direct and shape their markets, limiting the influence of the market on them. For Galbraith, this was expressed through Edward Chamberlin’s (1933) monopolistic competition theory and Adolph Berle and Gardiner Means’ (1932) theory of managerial control. Blanket notions of rationality and of competition, for example, are primitive terms, saying very little about what is actually going on. And what is actually going on – for example, politics as economics by other means – is significantly different from the portrait given by neoclassical economics. Neoclassical economics is used in the process of working out political economic solutions, but as a tool contradicting the imagery of nonintervention. At bottom for Galbraith were several different systems of social control and several different valuational processes all with unequal power structures. Multiple systems of social control and valuational processes Adam Smith’s total model of society had three parts: the moral sentiments, such as sympathy, and the working out and enforcement of moral rules; the market; and government and the working out and enforcement of legal rules. All three are systems of social control or regulation. Galbraith was, with one important exception, not a moralist. The exception has to do with the moral desirability, and economic justification, of policies which enhance the lives of the poor and dispossessed and of policies which protect the environment in a democratic society. There must be moral rules having influence on legal rules and Galbraith

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favored those which typically differ from the rules and world view of the contented. The processes by which moral and legal social control is worked out, as well as the market as a regulatory system, are valuational in nature. They comprise the search for, formulation of, and experimentation with values and then their critique and reconstruction. Parker is especially insightful on Galbraith’s view of the existence of multiple systems of social control and valuation. He writes that for Galbraith “efficiency alone was already only one criterion among many worth considering” (p. 5; all unidentified references are to Parker, 2005). Galbraith rejected “the nineteenth-century liberal idea that markets offer the true path to prosperity and security” (p. 663), that markets “were now the omniscient, the omnipotent, the omnipresent metrics by which all was to be measured” (p. 590). He refused to have as “ ‘the sufficient and only test of social change’ ” whether “ ‘it reduces prices to the consumer.’ ” He believed that “there was a different metric than simple ‘allocational efficiency’ by which to judge an affluent democracy’s economic performance” (p. 243; the long internal quotation is from Galbraith). The reasons for this are both positive and normative. The positive reason is that in any society more than one process of social control and valuation are operative at the same time. The normative reason is Galbraith’s affirmation of the value of democracy. Parker writes of both reasons when he says, “Democratic government relies on choices about values, which can’t be made by markets alone” (p. 302) and that production must be considered in “its connection to larger democratic purposes” (p. 297). On both grounds Galbraith wanted the Soviet Union and its successors to avoid both shock therapy and reform that was only the renewal of socialism, and favored gradualism in institutionalizing changes toward authentic capitalism and social democracy (p. 621 and passim). Parker writes about the second reason when he relates that Galbraith is concerned “with the political effect of the American economy on American democracy and the need to formulate public policy that didn’t weaken the latter while strengthening the former” (p. 100); and that “A pragmatic balance between the opposing ideological ideals lay at the heart of Galbraith’s reasoning. The market has value, but so does the state when it acts in the democratic interest. This is the core of the Galbraithian approach to economics” (p. 133). The conflict between those with different interests and/or positions in the market and in government takes the form of jockeying for position over relative roles and over prices and profits. And when he writes that “. . . the difficult, practical question was how to balance the needs for freedom and security in a complex industrial society,” the conflict is between a new and the old mixes of social control, or of valuational processes and of values (p. 198). Democracy and the growth of government The central question arising in Galbraith’s political economy concerned the relationship between increased democracy and the growth of government. The

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question is complex, is laden with ambiguity and opportunity for ideology (in part, in the form of antecedent normative premises), and permits no single answer. The same may be said of democracy itself. For Galbraith democracy meant government being increasingly responsive to the interests of the great masses of people rather than the upper, wealthier, or ruling classes. It meant full-employment policies that promote opportunity and a decent living for workers, the poor, and those unable to work. It meant that the shibboleths by which the wealthy seek more for themselves – tax cuts to increase their incentives by which to provide jobs for the workers – no longer serve as rationalizations. There are two competing ways of promoting growth. In one, a saving-investment elite is further enabled to save by government policies that increase their wealth. Greater saving by the wealthy is presumed to lead to greater investment and thereby to higher GDP and employment. In the other, government policies promoting the income position of the mass of middle class and poor families enable them to consume and save more. The principal sequence here is greater consumption leading to greater income and investment and thereby to still higher GDP and employment. Democracy, however, does not mean only growth of private consumption. It means environmental protection. It also means greater provision of the types of collective goods advocated in The Affluent Society. In all respects it means severing the hold which the needs of corporate production exert on private consumption, so demand determines supply, not supply determines demand (Galbraith’s “revised sequence”). Instead of complacently considering political and economic inequality as the natural order of things, Galbraith seeks to promote political and economic democracy; his concern with inequality is a continuing theme because resource allocation driven by inequality denies full participation by a democratic public in favor of “powerful, self-serving, pompous, and sometimes misguided elites” (p. 298). “[P]ower and politics did matter” and “democratic government needed ‘emancipation’ from powerful economic interests in order to be truly democratic” (p. 505, quoting Galbraith). The growth of democracy in the manner sketched above means a change in the interests to which government lends its support, along a wide front of activities. Government may protect the interests of Alpha or of Beta. If until now it promotes those of Alpha, changing the law to promote Beta’s interests does not mean more government. Galbraith did not theorize explicitly along those lines, though that mode of theorizing is useful, and it does serve to highlight a Galbraithian theme. Galbraith did not consider the growth of government spending in and of itself necessarily to constitute more and bigger government. Comparatively very little actual government spending need be pursued in order to promote the interests of the owners of great property (though they do receive much); whereas promoting the interests of the masses may involve much greater spending. The change of interests given government support involves change in spending level but the latter does not necessarily connote more government. From Galbraith’s perspective, with regard to the level of government spending or government spending as a percentage of GDP, “The issue is not its size but the purpose to which its spending is put and the sectors from which its revenues are collected” (p. 663). In the late twentieth-century period of Republican

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success, “it was not the size of government, but the reordering of its revenue and spending priorities that angered him” (p. 627). On governmental activism Given the model just outlined, government is inevitably activist. Whenever Alpha and Beta are in the same field of action and conflict, government in the modern world is the institution determining whose interests are to be promoted. That is why modern government, for those who see it this way, is the object of a contest over the control and use of government to promote Alpha or Beta interests. Rationalization of existing rights enjoyed by the Alphas may or may not be justified but the use of government to that end is governmental activism – and when government is used to promote Beta interests it will be neither less nor more activist, whether government spending rises or falls. The point just made is important here for two reasons. First, Galbraithian governmental activism clearly involved changing the interests to which government lends its support or is used to support. Strong and effective environmental protection policy may look like activism in the sense developed above but such activism only changes the interests given protection by government. Environmental degraders hitherto have had their felt interests protected; now it is the reverse, and the change does not signify bigger government. Emphasis on the growth of government spending on the environment is ironic once it is realized that businesses often prefer government spending out of general revenue to clean up their messes rather than lose the protection hitherto given their interests or have taxation imposed on them. Second, Galbraith had a tendency either to say or to imply that government involvement is actually growing at the most fundamental level, and such is amply reflected in Parker’s exposition of Galbraith’s ideas. One would not grasp the historic and deep activist involvement of government in the economy from the following: • • • •

•

•

Roosevelt’s programs “thrust toward an activist government’s deep involvement in America’s capitalist economic in order to save it” (p. 11). “American government at mid-century was much larger and far more involved in the economy than in Marshall’s time” (p. 242). “government’s newfound power over economic life circumscribed that of the baronial corporate dynast” (p. 286). “American politics has become increasingly polarized around a . . . conflict [that] is basically over income distribution” (p. 625, quoting an American Enterprise Institute study). “these corporate elites extended their power over and into the public sector. [They have t]he ability to turn democratic governments into the allies and handmaidens of big companies” (p. 639). “a market system that was now permanently entwined with government” (p. 623).

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None of these points is strictly correct: Roosevelt did not further deeply involve government in our capitalist economic order; it was already deeply involved, already permanently entwined with the market system well before Marshall’s time. As for conflict over the distribution of income, much of US political and economic history, as well as the history of economic thought, was driven by that conflict. The capture and control of the public sector by business is by no means a post-World War II phenomenon. This position, in my view, is misleading for the reasons sketched above. Galbraith was, in this matter, either too caught up in the language and imagery of day-to-day politics or too willing to accept the ideology of his opponents as the basis of his articulation of his own position. But it is only a tendency. Galbraith also acknowledged the inevitable, deep, and important involvement of government in the economic system: “the market’s borders were artifices concealing deep political presuppositions. . . . [government had a] central role in helping to create modern capitalism” (p. 247). The interdependence of economic and political power The foregoing was part of Galbraith’s larger and deeper argument, namely, that the legal-political and the economic systems are inevitably mutually determining, i.e., the interdependence of economic and political power (p. 61), a theme which Parker properly restates and invokes from time to time and in varying contexts: Galbraith did not consider the economy as a world “that incorporated government as an ‘exogenous’ afterthought, as something ‘outside’ economics.” Galbraith is quoted as having said, “economics does not usefully exist apart from politics” (pp. 529–30). “Galbraith argued that the truly important economic issues must be evaluated through the lens of economics, politics, sociology, law, ideology, and history simultaneously . . . always keep[ing] front and center both the factors of power and the narratives that societies use to tell their economic stories” (p. 653). Of course, it is one thing to say, for example, that nineteenth-century banking, even under the Independent Treasury System, was unregulated, even though there was a body of money and banking law that chose between Alphas and Betas, and quite another to emphasize “the importance of activist government in regulating financial markets” (p. 268) as we know such regulation today. But while the evident scope and complexity of regulation is vaster, contemporary regulation also chooses between Alphas and Betas. It is the same regulatory function but in a very technologically and institutionally different society. If government is inescapably activist, the question becomes, on behalf of whose interests is government to be activist? Early in his career Galbraith sought for farmers to receive the same respect and legislative treatment as did business. He also saw that regulation is, and always has been, a means of transforming property. The key social process is the contest over the control and use of government; and the correlative key to both Galbraith’s policy analysis and policy activism is his resolve to use government to promote the interests of the

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working class and the poor. Galbraith could not abide the doctrines of the right which purport to argue the case for the existing system especially as those doctrines omit serious and objective consideration of government, the legal factor of the economic system. It is the economic conservatives who maintain that the New Deal “represented an overt interference by government in the otherwise efficient workings of markets” – left alone, market problems were “self-correcting” (p. 12). “On the libertarian right, Hayek continued to rail against any government infringement on the workings of the sacred market” (p. 308). Galbraith lamented modern economics for its “willful denial of the presence of power and political interests” and its insistence that “individual firms or industries – no matter how large – are at the mercy of the market, and that the state and the interests of the most powerful and wealthy are at the mercy of the sovereign citizenry” (p. 505, quoting Galbraith). Parker writes that when, during the 1930s, Galbraith was a student, “it was a time when economists and public leaders accepted the inescapable influence of the state in shaping market economies” (p. 47). This was a descriptively accurate view but for practical purposes it was only, or largely, part of a system of belief. Not long afterward there were arguments over whether “government would still need [after the Depression] to maintain a strong visible hand in the economy” (p. 121). The emphasis here must be on “visible,” inasmuch as the dominant ideology renders much of what government does invisible or unseen. If “a new sense of the purposes, function, and extent of government was emerging” (pp. 121–22), it too was only a “sense,” a matter of belief.

The problem of the modern liberal For all of Galbraith’s activism, as author, political advisor, and public intellectual, he had, with the promise of a refurbished New Deal in mind, been extremely disappointed. Several ironies help explain his predicament. One was that the beneficiaries of government policy, hitherto have-nots and now haves, have become conservative. Federal programs promoting homeownership, for example, have increased the range of property ownership and the beneficiaries have emulated the conservatism of most of the propertied. In the process they have forgotten the past help provided by government. Parker thus quotes Galbraith: The unarticulated assumption of American liberals . . . [was] that the newly affluent . . . would, in gratitude, have political attitudes different from those of the older rich. And so, presumably, would their offspring. [But] the liberals were wrong . . . [and] were contriving their own political decline. . . . I do not predict that with increasing affluence, conservative administrations will always be in power . . . There are other things that decide elections. . . . I do suggest that one effect of affluence is a continuing conservative trend in politics. (p. 589)

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Another irony was that abuses of government power – Watergate, the set of illegal programs to help the Contras, housing scandals, abuse of corporate power with the help of government agencies, and so on – have soured attitudes toward government. The effect is ironic in that the abuses largely occurred during Republican administrations, yet the anti-government reaction has politically favored the Republicans (p. 590). Some of the explanation also resides in the deliberate policies and strategies of the Republicans and the putative ineptitude of the Democrats. Some also is due to the continuing ideological mindset of American civilization, in which deregulation, for example, is seen as the promotion of freedom rather than a change in the interest to which government is giving its support. Perhaps Galbraith did appreciate the problem. Parker writes that, “To Galbraith, this layered, interconnected relation between government and giant American corporations – and the conservative ideology that defended it – was the dilemma of modern liberalism and of Keynesianism” (p. 302). Some of the explanation, however, may be found in Galbraith’s own writings and in the reaction to them. Galbraith was a major critic of the corporate system and the plutocracy which was its driving force. The New Industrial State, we are told, “struck centrally at the business and public-sector organization of modern America” (p. 437) and that in Economics and the Public Purpose, Galbraith sought to help “break the hold of the great corporations on our national life” (p. 512, quoting The New York Times). Indeed, in the 1990s most Americans distrusted government but “nine out of ten said they now distrusted corporate America and believed that the wealthy and corporate elites had captured effective control of the government” (p. 631). It may well be, however, that Galbraith achieved ironic results. An alternative explanation apropos of his writings is that he was fighting not only the vested interests but the systemic ideology of the capitalist system, a difficult task. The hypothesis of his having produced results opposite to those he intended runs as follows. Galbraith had shown the corporate system presented in The New Industrial State to be powerful, indeed to have captured or co-opted both political parties and through them the government itself. Liberal policy has apparently failed to attract effective government measures to counter the power of business. Although Galbraith later reversed his stand opposing antitrust enforcement (p. 557), the early and long-time opposition of this most famous of economists may well have weakened people’s reliance on antitrust – and perforce on competition – to assure a socially beneficent economic system. If the power of business, whether in the hands of management, the technostructure, or whatever else, is entrenched, not only in the US but in the Soviet regime, how can either an individual or a reform movement or government itself successfully fight it? The alternative is to accept and join it – a course of action that is eased by the belief that the system produces bountiful goods and services. The results of Galbraith’s writings may be more than the irony of unintended results. Parker tells us that American Capitalism “was Galbraith’s first major attempt to reconcile liberal aims with a market economy dominated by large cor-

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porations. . . . The large corporation, he argued, was the defining economic institution of modern capitalism possessing a capacity for technical innovation and constant progress that justified a cautious acceptance of it” (p. 659). Galbraith is thus said to have “accepted the reality of business concentration as an inescapable given” (p. 72). Parker also indicates that American Capitalism attacked the conservatives’ property-equals-freedom argument, the marginalists’ claim that competition equaled efficiency, and the liberals’ belief that economic concentration inevitably undermined democratic politics (p. 237). He quotes Galbraith, that American Capitalism “does not deny the role of competition as a solvent for economic power. It does argue against efforts to dissolve positions of economic power as the principal remedy” (p. 244). After all, as Parker quotes Galbraith, “to suppose that there are grounds for antitrust prosecution wherever three, four or a half dozen firms dominate a market is to suppose that the very fabric of American capitalism is illegal” (p. 240); such is too mind-boggling to catch hold. Perhaps too much has been read into the negative reactions to Galbraith’s work by businessmen, conservative pundits, anti-socialists, and some orthodox economists, some of whom would oppose almost any change of the law. The language of reconciliation (Parker), while it encompasses criticism, is not that of extirpation. Saying that the analysis of the working out of the definitions of democracy, freedom, equality, and justice “supersedes in importance issues of price and efficiency” (p. 667) may lower the pedestal of economics but it hardly constitutes rejection of the system – unless one’s opponent is either playing the ideologist’s game of absolutist legitimization and/or being incredibly complacent about the problems of poverty, inequality, and the environment. It is telling – again except for the extreme opposition – that Parker concludes his final chapter, “The Galbraith Legacy,” with Amartya Sen’s work as a brilliant response to Galbraith’s challenges – even if Sen did not have Galbraith in mind. In addition, the corporate system was the beneficiary of many people looking forward to their children (if not themselves) becoming part of the well-to-do, hence opposing higher taxes, regulation of business, and so on, even when these policies were putatively in their interest. The predicament is exacerbated by a major if subtle shift in the strategy adopted by Republicans and other conservatives. For the first thirty or so years after the 1930s, opponents of New Deal programs adopted the negativist strategy of labeling them “socialist.” More recently, these opponents have adopted the strategy of identifying putative problems with these programs and the need to reform them in order to save them but arguably to commence their destruction. Social security is a principal case in point. Deregulation did not seek to rescue us from regulation but to avoid the problems advertised as due to regulation. This new, seemingly compassionate, approach was, of course, supplemented with ideological tropes of long standing, such as regulation negates freedom, people should be able to spend their own money, the glories of owning property, and so on. The predicament is further exacerbated by the positions and policies of the US vis-à-vis the rest of the world. The US has increasingly aggressively pursued

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its ostensible business and national self-interests in ways that have eclipsed the other grand tradition of US foreign policy, that of a humanitarian, cosmopolitan and live-and-let live regime. The goals of spreading liberalism and liberty have been increasingly equated by many foreigners as the means by which US imperial power is exercised and rationalized. To the extent that the US has vigorously pursued its economic interests, other countries have done likewise. The situation is aggravated by the largely unilateral military, economic and other policies of the administrations of George W. Bush. The most recent phase of the global economy seems to be one in which labor in Third World countries is being brought, in part through outsourcing and in part through conventional production arrangements, into competition with higher priced labor in the developed countries. This has the effect of exerting downward pressure on the wages of such labor and on the welfare state programs of their governments. The long-term trend will have wages and programs rise in the hitherto less developed countries; in the meantime, governments will be used to enhance the opportunity sets of businesses engaged in global trade. Much of the foregoing subtly operates to give business a relatively free hand to use government for its purposes, having negated and otherwise finessed others’ efforts to use government as so much socialism, etc. One episode suggests the ubiquity and depth of the problem. Parker reports Galbraith’s early experience with wealthy white farmers’ management of crop-allotment payments in a manner disadvantageous to non-white sharecroppers (pp. 64–65). Galbraith was a modern liberal, concerned with “reconceptualizing government as an instrument of the popular will which could and should limit the new power of giant corporations and trusts, economic structures that had appeared during industrialization and that were taking on the often brutal and arbitrary power associated with political despots” (p. 236). Whatever the reason, or combination of reasons, either this view did not have staying power or it was subject to the cycle of periods of liberalism followed by periods of conservatism. Parker writes that “Governance is not a neutral activity, and successful democracies require advocates of authentic reform policies . . . to foresee and develop public understanding and support for their plans” (p. 303). This may or may not be a correct diagnosis – public understanding in a world of Paretian mutual manipulation of psychology and belief is a much more complex affair – but at best it is only a statement of the problem, not a solution. But solutions require “correct” definitions of the problem and certainly Galbraith attempted to provide such definitions.

Power The central concept of Galbraith’s political economy is power. As Parker says, “Power – a concept so uncomfortable to conventional economists because it disrupts the very workings of economic theory – was a central and defining idea for him” (p. 67). Dating perhaps from his studies at Berkeley, Galbraith’s funda-

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mental insight was that the economy, especially the capitalist business economy, was a system of power. Everything else either derives from or relates to that fundamental insight. In a modern capitalist economy, power is both the cause and the consequence, as well as the predominant motivation, in the process of mutual impacts between law/government and economy. In that context, what I have called the legal–economic nexus (Samuels, 1989) is both inevitably activist and an object of capture and use. Government is used to establish, reinforce, and extend private economic power; and private economic power is an object of legal control. As it turns out, many, perhaps most, people, including Galbraith, accept as a “natural” and a reasonable exercise of important rights that business spends money hiring politicians and lobbyists to “manipulate public regulation and laws that influence their industry and market performance” (pp. 439–40) and that American politics is “a struggle about power . . . and about the ability of the corporate ‘planning system’ and its allies to bend the government to its purposes” (p. 505). “We put limits on government because we don’t want it to dominate our lives. But, in turn, we rely on government to check concentrations of private power. Americans have always been suspicious of excessive power residing anywhere – in government or in parts of the marketplace” (p. 650). All economies are systems of decision-making. If power is understood to be participation in decision-making and its legal bases, perhaps the most that can be expected, given acceptance of the basic system and/or the impossibility of fundamentally altering it, is the removal of felt antisocial power structures and abuses of power – at bottom a matter of the unequal distribution of power. It is because of his belief in the centrality of power that Galbraith lamented that economics has, in his view, so much become the tool of the powerful and the conservative, providing conservative economic policy with its agenda and/or its rationalization. (Conservative and other critics of Galbraith’s work claim that he offers no rigorous empirical and theoretical support for his arguments and that the arguments are due to his liberal if not socialist ideology. Galbraith could just have readily wondered as to the conclusive scientific basis of, for example, Milton Friedman’s claims about the quantity theory, the Phillips curve, the natural rate theory of unemployment, and so on, and whether they, like Friedrich Hayek’s theory of spontaneous order, is attractive because of its ideological appeal and political use.) It is not just economics as the tool of the variety of conservatives to which Galbraith objected. He learned from his experience with the Strategic Bombing Survey that interest influences one’s definition of reality and attitude toward and use of the Survey’s results (Chapter 9). The same lesson came earlier from his experience with inflation control at the Office of Price Administration. He saw “how ostensibly ‘neutral’ scientific research was reshaped to serve institutional and doctrinal goals” – through misrepresentation and concealment (p. 190). Further apropos of Hayek, Galbraith can be seen as the Hayek of the left. Each is a student and philosopher of the economic system. Each is activist in pursuit of his ideal system. Each has his own conception of when and which concentrated power needs to be checked. Each has a felt need to puncture the

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dominant rationalizations and conventional wisdom of the other side. Each feels that he must identify and rebut the lines of ostensible reasoning that enable the powerful to control the powerless.

Conclusion As with other economists, Galbraith’s technical work (his positive analysis) and his political activism (his normative position) were two intertwining aspects of his intellect. That these reflected, as aspects of his biography, his selective perception, sentiment, and ideology, says nothing of the accuracy of his ideas. Galbraith is intellectually located in a long line of economists – many of whom can be called institutionalists – who supported the market economy but were critical of its existing structure, particularly its domination by capitalists and its ill-treatment of workers, the poor, and others. These economists were also critical of mainstream economics for both obfuscating the foregoing and serving the vested interests. They wanted to reform both the actual capitalist economy, without changing its basic nature as a market economy, and economic theory. They wanted people to appreciate that the same interests who loudly said they opposed government intervention also had their own interventionist agendas. And they wanted people to see and comprehend the implications of the economy having legal foundations. This the apostles of laissez-faire did not want to acknowledge – either that or the reformulation of laissez-faire it implied, preferring instead to denigrate and marginalize those whom they found subversive of sound ideas. Like many institutionalists, Galbraith was a pragmatist. The institutionalist conception is that of a process of working things out – through multiple systems of social control, through multiple valuational processes, through pluralism and democracy each signifying diffusion of power, and in a pragmatic manner. Although contesting participants often spoke in terms of absolutes – absolute absolutes or relative absolutes – it was all a matter of jockeying for position as to power and prices. Parker includes among Galbraith’s objects of scorn “the shibboleths of an affluent, anxious Americana elite that strived incessantly to portray its values and interests as universal ones” (p. 579). As Parker stresses, Galbraith’s career resembled that of John Maynard Keynes. The Great Depression was instrumental in forming Galbraith’s definition of economic reality. It was from Keynes that Galbraith learned how to be a useful economist – “a model of the economist as an engaged and politically purposive intellectual,” including work as a popularizer (p. 96; see also 659). Keynesian economics gave Galbraith and numerous others a socially constructive purpose (p. 86). From Keynes he also received “a model of how elite social and political networks shape acceptance of economists’ theories, a matter seldom formally or openly discussed” (p. 96). Keynes’s example may well have helped form “Galbraith’s talent for making friends with wealthy and powerful people” (p. 97). Galbraith’s approach to economics, his political economy, can be seen in two

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contexts. One context is the model of worlds of thought identified by George Shackle (1967, p. 294): There is the world of what we take to be “real” objects, persons, institutions and events; on the axis of abstract–concrete this world is at the concrete pole. There is the logical or mathematical construct or machine, a piece of pure reasoning, almost of “pure mathematics,” able to exist in its own right of internal coherence, as a system of mere relations amongst undefined thought-entities; this world lies at the abstract pole. And between these two worlds there lies the world of names, linking the real world elements with the undefined entities of the abstract machine. Galbraith clearly worked within the first world, though modified by aspects of the second and third. It is in this world that we can locate the principal topics and/or themes that constitute his deepest paradigm: the several forms of social control; the several modes of social valuation; the conflict over decision-making, or power; the contest for the control and use of an inevitably activist government; the interpenetration and mutual creation of law and government, on the one hand, and the economy, on the other; the explanatory and normative significance of inequality and class; the role of democracy; economic theory in relation to policy making; and so on. Galbraith’s political economy undoubtedly is not the last word on its subject. But it seems to say more about what is really going on in economic, or legaleconomic, life than the pure theory of those he opposes and who oppose and ridicule him. Much of that pure theory, it is now widely admitted, does not apply to the actual economy. The second context is derived from a distinction made by Abba Lerner. Lerner distinguished between a political problem and an economic transaction. Political problems involve conflict. Economic transactions require at least tentatively solved political problems. An “economic transaction is a solved political problem.” The solution involves “essentially the transformation of the conflict from a political problem to an economic transaction” (Lerner, 1972, p. 259; italics in original). Galbraith’s position, like that of all institutionalists, was that “what Lerner calls ‘political problems’ are never ever ‘solved’ once and for all” (Sturn, 2004, p. 328; italics in original). If one thinks of the market-plus-framework model of the political economy, in which the market is in part a function of the framework institutions which form and structure it, then there are two simultaneous processes going on. One is the working out of optimal solutions through trade. The other is the working out of the framework. Neither process is ever “solved” once and for all. That is why “most economic debates are ultimately political ones” (Parker, 2005, p. 528). There is neither one unique optimal solution nor one unique power structure. There are a group of optimal solutions each derived in part from a corresponding power structure. Economic agents compete not only for resources but over the framework. Politics is economics by other

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means. That is what the contest to control and use government is all about. Government is an object of control because government is ubiquitous and important; and because government will be present willy nilly, it is mandatory that the democratic government process identify and serve public purpose and not be captured for private purpose. That, in large part, is what Galbraith’s most fundamental system was all about.

References Berle, A. and Means, G. (1932) The Modern Corporation and Private Property (New York: Macmillan). Chamberlin, E. (1933) The Theory of Monopolistic Competition (Cambridge, MA: Harvard University Press). Galbraith, J. K. (1952) American Capitalism: The Concept of Countervailing Power (Boston: Houghton Mifflin). Galbraith, J. K. (1958) The Affluent Society (Boston: Houghton Mifflin). Galbraith, J. K. (1967) The New Industrial State (Boston: Houghton Mifflin). Galbraith, J. K. (1973) Economics and the Public Purpose (Boston: Houghton Mifflin). Galbraith, J. K. (1983) The Anatomy of Power (Boston: Houghton Mifflin). Galbraith, J. K. (1992) The Culture of Contentment (Boston: Houghton Mifflin). Lerner, A. (1972) The Economics and Politics of Consumer Sovereignty, American Economic Review (Papers and Proceedings), 62, pp. 258–66. Parker, R. (2005) John Kenneth Galbraith: His Life, His Politics, His Economics (New York: Farrar, Straus & Giroux). Samuels, W. J. (1989) The Legal–Economic Nexus, George Washington Law Review, 57, pp. 1556–78. Shackle, G. L. S. (1967) The Years of High Theory (New York: Cambridge University Press). Sturn, R. (2004) Review of W. J. Samuels, Economics, Governance and Law, European Journal of the History of Economic Thought, 11, pp. 328–30.

Part III

Post Keynesian macroeconomics in a changing world

10 Statics and dynamics in economic theory Mark Perlman

Introduction John Bates Clark was perhaps the last to distinguish between static and dynamic analysis, albeit that there has been no end to the argument that “your” dynamics is no more than “my” comparative statics.1 Others, like Karl Marx, used the distinction facilely, but only those who could understand Marx (in most cases limited to those who read Capital in the original German) appreciated that his statics were analytical, his dynamics synthetic. I became aware how much static analysis had become synonymous with academic economics during a 1947 conversation with Jacob Viner when he asked me what Wisconsin’s Institutionalism had to show for itself. My reply, “Our social security program,” elicited no more than a snort and, “That’s not economics. All that counts is theory.” Viner was at heart a Marshallian neoclassicist; nonetheless he seems to have paid scant attention to the closing chapters of Marshall’s Principles (1920a) where the focus is on the historical evolution of national income, both in terms of its “theory” and its facts, or the thesis of Marshall’s last great work (originally intended to be the second volume of the Principles), Industry and Trade (Marshall, 1920b).2 Although I did not then realize that Viner and John Maurice Clark were old and dear friends, I recall telling the story to Clark when we were discussing the ambit of my doctoral examinations in economic theory. We agreed that we would start with a methodological comparison of Marshall’s Principles and his Industry and Trade. I wanted to follow this with Hobson’s The Evolution of Modern Capitalism (1916) but that examination was never held.3 The thrust of this essay covers what I had hoped to use to impress John Maurice Clark – the approach to economic dynamics that I learned in my time at Wisconsin, not so much for the reason that it is interesting in itself, but to indicate how much has been sacrificed when analytic statics crowds out from the graduate curricula all discussion of the various syntheses of institutional evolution and their effects on economic thinking.

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The thrust of Wisconsin Institutionalism Wesley Clair Mitchell, an admirer of the work of John Rogers Commons, believed that modern economics was coterminous with institutional changes associated with “modern” (since the mid-eighteenth century) adaptations involving industrialization and urbanization (see Mitchell, 1967, Vol. I, ch. 1). Commons thought that modern capitalism (by which he meant industry) had its obvious origins in collective bargaining, of which the barons’ struggle with King John (Lackland) in 1215 at Runnymede was an early signal event. Commons pioneered a method of using court cases as “balanced” evidence of the formation of new standards (unlike statistical numbers, the evidence in court cases is at the time of its presentation generally subject to hostile cross-examination, a form of vigorous criticism). Although Selig Perlman’s own research work was best reflected in his course, “American Labor History,” and his best-known course was “Capitalism and Socialism,” I once told him that his best course, by far, was “Evolution of Modern Capitalism.” To my surprise he agreed, noting that it contained by far the greater number of facts and ideas from different sources, including empirical syntheses. Given his earlier belief in Menshevik Marxism with its emphasis on the deus ex machina of technological change, and his later exposure to Commons’s contrary view that a great deal of modern social conflict stemmed from market expansion or deepening, with its advantage of lower product prices and disadvantage of resultant lower wages, Perlman went on to consider the role of religion, secularization, and competing ideologies (cultural as well as political) as additional factors in the historically changing nature of industrial and financial capitalism. For Perlman the evolutionary “growth” of capitalism in many instances started with the use of collective bargaining by a socially inferior group to achieve some measure of equality with the superior group: Collective bargaining is not just a means of raising wages and improving conditions of employment. Nor is it merely democratic government in industry. It is above all, a technique whereby an inferior social class or group carries on a never slackening pressure for a bigger share in the social sovereignty as well as for more welfare, security, and liberty for its individual members. As such it is not confined to a single arena, the industrial one, where employers and labor unions meet directly, but manifests itself equally in politics, legislation, court litigation, government administration, religion, education, and propaganda. Nor is collective bargaining only a phenomenon of modern society. On the contrary, its clearest and most comprehensive manifestation was shown by the urban communities in the Middle Ages – the boroughs and the guilds in the struggle against feudal lords. Collective bargaining as a technique of the rise of a new class is quite different from the class struggle of the Marxians. It is nominalist instead of realist. It is pragmatic and concrete instead of idealist and abstract. It is

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much less concerned with algebraic formulae summing up basic economic trends than with the problems of building discipline in organization and of training leadership. It derives its emotional impetus not from the desire to displace or “abolish” the “old ruling class”; but from the wish to bring one’s own class abreast of the superior class . . . . (S. Perlman, 1936, p. 154) The key idea in this quotation is not necessarily “collective bargaining” but instead the point that such research “is nominalist instead of realist. . . . It is much less concerned with algebraic formulae summing up basic economic trends than with the problems of building discipline in organization and of training leadership.” If one reads carefully Alfred Marshall’s Industry and Trade the “snake under the blanket” is just that. This focus on nominalist facts rather than realist abstractions was in only one sense what really separated Wisconsonian from Marshallian, as well as Hicks–Samuelsonian, neoclassical economics from emphasis on what Marshall called the trend or others more recently have relegated to that catchall the “very long run.”4 The second, and perhaps more significant difference, was that the Wisconsin Institutionalist tradition worked not toward analytical breakdown but towards synthetical reasonableness (given one’s knowledge of history in all its complexities).

Winsconsian synthesis: Selig Perlman’s theses about the evolution of modern capitalism The changing organization of markets The medieval “traveling merchant” gave way to the emergent medieval and Renaissance “sedentary merchants,” who in time gave way to the medieval guilds and then to the Renaissance guild companies. But it was the experience of the transition from the Tudor Elizabeth I to the Stuart James I which offered to Perlman a key to the way that governments operated. Elizabeth, like her father, was so cleverly conniving that she trusted her capacity to delegate what might be called the “Economic Prerogative,” namely the merchant companies of London were allowed to set standards and police themselves (e.g., the wool merchants certified the authenticity of the composition of wool cloth). James I had no need to play economic politics, and when he ascended the joint throne of England and Scotland sought to have his hand in all regulatory activities. The two British historians George Unwin (who stressed the stability of the Elizabethan reliance upon delegation) and Sir William Ashley (who could recognize growing oligopolists and even their elite, the oligopsonists) understood why James and his successors attempted to do what they could to put down the very, very rich. The Civil Wars were the result, and eventually while the monarch was allowed to reign, it was the Parliament that ruled. But by the eighteenth century with the British mechanization of the textile

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industry, capitalism reinvented itself in an industrial form, and by the end of the nineteenth century, market speculation and the need to stabilize competition (if profits were to be widespread) led to cartelized finance capitalism, and the common thought was that eventually there would be state capitalism. Individuals’ capacity for non-worry Others thought capitalism relied on a propensity for risk-taking. Jacob Fuggar, the banker to Charles V, is supposed to have said that “the minute my head contacts the pillow I am asleep.” This seemed to be Selig Perlman’s prime explanation. It was based on two quite different observations about human nature. For one thing, he argued that economic expansion was basically an inexplicable psychological occurrence (similar to the Joan Robinson/Maynard Keynes “animal spirits”). Second, he thought that a four-way division among people accounted for most attitudes: 1

2

3

4

There were the supreme optimists who had no fears of full market warfare. They were the Andrew Carnegies, the Henry Fords, and the William Gateses. Each was convinced that with the combination of his skills and his nerves he could survive and prosper. These were the progenitors of buccaneer capitalism. There were the fearful competitors who thought that the buccaneers could and should be controlled. Governments were to keep the big pigs’ trotters out of the trough through programs of antitrust and standards for normal competition. Like the supreme optimists they put their faith in private capitalism, but unlike those optimists they were pessimistic about their capacities to survive sans favorable social action. One of their principal heroes was Louis Brandeis. Then there were the optimistic socialists who were against private ownership of the means of production and distribution. Political decision-making and expert allocation-direction could “solve” such questions as levels of investment (postponed consumption) and equality of economic allocation. Given their belief system with its emphasis on education and result-equality, they could be said to be optimists. Selig Perlman identified several kinds of socialists: Ethical or Christian; Efficiency or Fabians; and Scientific, including not only Marxians but also subdivisions within that group including followers of Bernstein and Plekhanov, Lenin and probably Trotsky, Stalin, and even Mao Tse Tung. Finally there were scarcity-conscious unionists on the workers’ side and worry-haunted industrials who turned to cartels on the manufacturer/ employer side. Like the anti-monopolists they feared the instability of the unfettered market. But unlike the socialists they put little faith in the good intentions of politicos and civil servants. Rather, they relied upon their own agreements with others in their same position and used collective bargaining (with its strikes and lockouts) for dynamic equilibration. Probably the

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ablest advocates of cartels were the Rathenaus, father (Emit) and son (Walter). Selig Perlman contended that dynamic change came in good part from entrepreneurs’ willingness to adopt technological improvements and to extend markets, both laterally and vertically. While in economic statics it was possible to employ analytical concepts like ceteris paribus and pari passu, they had little or no meaning in economic dynamics, if only because the possibilities of different influences were all but limitless and controlling any number of them while varying others seemed generally impossible. If Ricardo and Mill and others could demonstrate how unfettered international trade (once von Thuenen’s transportation costs were considered) provided benefits for all aggregated economies under economic statics, Perlman’s own view (quite typical of labor economists of his generation) was that cheap imports and unlimited globalization of production (without reference to International Labor Organization standards) would surely injure domestic producers (both employers and employees). This would be the case not only under static conditions but even more so under dynamic conditions. Other purposes of the market Aside from the exchange of goods and services, what other functions did the market serve? For one thing, there were rules pertaining to the right of access – the guilds, for example, worked to exclude non-member competitors and to ensure a supply of cheap labor through long apprenticeships. And even for members there were rules about sharing “lucky buys” (the Rule of Lot), and limits on nepotism (the taking in of nephews, sons generally being allowed). Trade barriers pertaining to “foreign wares” and barriers to the hiring of greenhands (and in the case of America, greenhorns) were often present, as were Factory Acts limiting the use of child or female labor. George Stigler, Friedrich Hayek and others have come to see the essence of the market place as a signal center; Selig Perlman, a Russian Jew who had had personal experience with Tsarist discriminatory legislation, thought it even more basically a place where the rights of “local citizenship” were actually tested. Finally there were questions pertaining to matters of social responsibility. In the medieval world the nobility, the landed gentry, the clergy, and successful merchant-artisans all had power, although the degrees varied among these groups over time. When, for example, sheep-grazing in England became more profitable than food cultivation, the peasants were driven off the land and languished under far worse conditions in towns and cities than they had enjoyed in villages. With industrialization the ordinary city-folk had to be educated to work steadily for continual periods – not infrequently from sun up to sun down. As some workers developed rare skills, they began to unionize and demand better wages, better working conditions, and eventually the right for male adults to vote. For persons of Selig Perlman’s generation free public schooling was seen

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as necessary if the citizenry was to be sufficiently educated to vote intelligently. Governments were responsible for public safety with the added proviso that different levels of government were allocated protection from different kinds of insult. Put briefly, “progressive governments” became increasingly responsible for the vicissitudes of employment associated with the business cycle.5

Some comments on the contemporary required readings Unfortunately almost all economics curricula focus only on analysis, not on synthesis. The two are quite different arts. The first stresses abilities to construct logically coherent models. The second is a more subtle art, perhaps best illustrated by exemplar works such as the following. Capitalism as an efficient production-system, but one leading to serious maldistribution of income: John A. Hobson From my own standpoint the most creative of all the several books I intend to cite was John Hobson’s The Evolution of Modern Capitalism, first published in 1894 although here I choose to describe the 1916 edition. Hobson was the exemplar professional economist outsider,6 a truly middlemiddle-class Midlands Englishman (raised in Derby), who chose as his Oxford major the study of Greek and Roman civilizations, albeit he acknowledges that early on he became enchanted with Ruskin’s views combining aesthetics and materialism (cf. Hobson, 1938, pp. 38ff.). Clearly an economics autodidact, his energy in looking up episodic and numerical data gave him among American instititionalists a reputation that he clearly lacked in his home country until Maynard Keynes praised him greatly in his 1936 General Theory. Hobson’s “trouble” was his un-credentialed originality.7 He clearly was sympathetic to Ruskin’s brand of socialism. Some thought he was also a Marxist, even sympathetic to Soviet Communism.8 In 1884 Hobson published with a co-author (A. F. Mummery) The Physiology of Industry, a tract arguing the case for under-consumption by workers and over-investment by rich owners. While he identified Malthus as having had some of the same ideas, he was apparently not aware of Sismondi and others who came upon them earlier. He was all too conscious, however, of their unpopularity after he was forbidden to teach economics courses in the University of London’s extension program. Throughout all of his writings, the undercurrent theme was the divergence of wealth between the capitalists (meaning the ownermanagers) and the manual workers (or as we would now use the term, “the middle classes”). His second big idea was economic imperialism, which was strengthened greatly by his view of the Jameson Raid and Cecil Rhodes’s activities in South Africa. His thinking on economic imperialism explained why profit-maximizing firms seeking product and factor markets abroad began to control national public policy in the latter decades of the nineteenth century. His view of imperialism

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eschewed the role of dynastic or other politico-nationalistic territorial ambitions in favor of economic motives.9 His Evolution of Modern Capitalism focuses as much on the welfare of manual workers as it does all other questions, but always from the standpoint of British history.10 He starts by asserting that in his view the sources of investment capital were the earnings retained by (1) land owners “exploiting” their “peasants,” (2) ecclesiastical authorities “exploiting” the “faithful,” and in time (3) successful merchants, who on mercantilist principles maximized output by paying their workers no more than the approximate costs of survival and procreating. He then turns to the dynamic institutioncreating roles played by technological- and process-improvements, making it amply clear that the latter – particularly as they relate to business forms and structures, have their own critical impact, such that in time they equaled and then superceded taxes raised by governments. By the eighteenth century the technology of first the cotton-weaving industry and then the iron–steel industry accelerated the rate of capitalist dominance. Indeed, his greatest criticism is reserved for the basic illogic of underpaying workers, since absent their capacity to buy goods, “gluts” (to use Malthus’s phrase) inevitably occurred. Thus for him the early heroes of capitalism were misguided, self-serving, narcissistic social buccaneers. But also included were his extensive investigations of how they worked – involving evolutionary legal forms of business organization (e.g., trusts and combines), which also played critical roles in the expansion of mercantilistic, albeit international, market-controls.11 While he was not totally averse to the development of capitalism as such, what bothered him most was not only the growing maldistribution of wealth resulting, he thought, in the inevitability of Malthusian gluts, but the absence of social conscience in the evolving culture of greed. The fact that virtually no economist reads Hobson these days is an intellectual tragedy. The Hammonds and their focus on capitalism and human exploitation J. L. and Barbara Hammond published in 1926 a very readable book (much more so than anything Hobson ever wrote), The Rise of Modern Industry. Its principal, clearly anti-capitalism, focus was on social victimization as it occurred in the evolution of English (really British) economic life during and after the latter half of the eighteenth century. The basic intellectual setting of their many studies (of which the aforementioned is only the last12) stemmed from Arnold Toynbee’s13 famous Lectures on the Industrial Revolution in England (1884), originally delivered at Balliol College, the intent of which was to acquaint the recently admitted nonCaucasians to Oxford.14 If one “paints with a broom,” Toynbee’s propositions were five:

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d e

M. Perlman Some time in the eighteenth century British population soared. Inventions, originally in the cotton and iron industries, vastly increased workers’ productivity. Workers, first in those industries, demanded increased wages, shorter hours, and improved working conditions and used industrial tactics (unionization and strikes) to secure at least part of their demands. As their wages grew, so did their sense of self-importance, and they then turned to getting a political voice (i.e., the vote). Popular focus increasingly shifted from concentration on traditional religious goals (e.g., personal salvation) to the “new” religion, concentration on economic justice (e.g., perceptibly rising living standards).

What the Hammonds accomplished was writing a descriptive history of what modern capitalism (i.e., modern industrialization) did to its “victims.” When wool-raising was more profitable than food cultivation, landholders turned to the commons (which they controlled) and encouraged enclosure legislation; the land-working “peasants” were driven from their villages to towns and cities with precious little concern as to what could become of them. After black slavery was firmly outlawed, the capitalists turned to child labor with the result that working conditions deteriorated terribly (after all, a slave represented something of a capital investment, but children could be hired at no cost, and paid even less than subsistence wages – the life-expectancy of a chimney-sweep, for instance, was about 18 months post-starting that employment). Conditions in the coal and copper mines were hardly better. Dickens’s David Copperfield and Oliver Twist were only two of his graphic fictional accounts of what impecunious orphans faced, particularly in the factory system. Benjamin Disraeli built the “modern” Conservative Party on the basis of the rich showing social responsibility to those less fortunate than they.15 The Hammonds conclude this effort by identifying what they thought was the creed of “modern capitalism,” namely the “curse of Midas,” or what is now called the “culture of greed” – the rich becoming ever richer; the poor becoming, if possible, even poorer. Although I am sure that Hobson never deserved the label of being a “communist” rabble rouser, it is undoubtedly the case that the Hammonds, with their Fabian Socialist views, were active Labour Party supporters. Selig Perlman classified them as “efficiency-intellectuals,” meaning in their case not economic efficiency but social efficiency. Using the terminology presented in my 1958 Labor Unions in America, I would have said that they were the exemplar British variant of Christian Socialists. Their complaint against modern capitalism was its evident heartlessness. Their principal contribution was to assemble evidence that aided the effort to found the post-World War II British Welfare State. Their view placed the responsibility for “civilizing” economic markets squarely in the hands of governmental legislators and their administrators, the famed “efficient civil servants.”

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Religion and the ethos of capitalism: Max Weber and R. H. Tawney, Werner Sombart, and Lujo Brentano One of the few things that Joseph Schumpeter and Maynard Keynes believed-incommon was that “ideas matter.” A very significant group of economists, largely writing in the first third of the twentieth century, thought that capitalism was a set of institutions originating in theological ideas towards wealth accumulation, and in that sense modern capitalism sprung from religion. The Roman Catholics There was a general belief that Roman Catholic theology was associated with a legacy of feudalism, where those “charged” with managing both sectarian and civil society used their power to accumulate wealth, which was purportedly used civically16 – be it to aggrandize the community with great churches and other religious establishments or eventually to finance competition (including wars) between cities and national states. What is not readily explained is that if so many capitalist institutions were first developed in Italy, where most of the recognized traders were clearly wealthy Roman Catholics, that Catholic practice, aside from murmured scruples to the contrary, was not seen for what it was, namely institutionalized early modern capitalism.17 Double-entry bookkeeping was also a Venetian invention. And in the late medieval period as well as throughout the Renaissance the Medicis of Florence played at times the dominant role in international finance. Mention of these “facts” is made simply to raise the query of why all the great scholars of the fin de siècle (1895–1915) looked for the ideational roots of capitalism everywhere but among the Catholics. Surely they should have been sophisticated enough to realize that Pope Leo XIII, when issuing Rerum Novarum in 1892, was virtually unique (e.g., “making history”) in his denunciation of laissez-faire capitalism. The Protestants Max Weber, a German institutional economist who became in time one of the “fathers” of modern sociology, had made an early major career effort of synthesizing the ideational bases of different, particularly Southeast Asian, religions. One of his principal later generalizations, this time regarding the West, however, was that the evident interest Protestants had in maximizing their capitalistic fortunes was not merely the “love of lucre,” but a desire to seek some confirmation that they enjoyed Grace. We Americans, perhaps, should identify the public benefactions which followed the accumulation of massive fortunes by the Presbyterian Andrew Carnegie and the Baptist John D. Rockefeller, Sr. as demonstrating that making the fortune was essential to provide religious self-assurance; spending it was for them a somewhat more difficult duty, but one ultimately they managed quite well. In that sense they demonstrated what Weber had predicated. However, Weber’s exemplar Protestants, the Calvinists, like Calvin,

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himself, had been French Huguenots, driven into exile after Louis XIV revoked the Edict of Nantes. Americans often are unaware of how powerful an economic group they were; their leaving France had much the same effect that the 1492 expulsion of the Spanish Jews had had on Spanish domestic economic life. As mentioned earlier, Weber’s thesis was revised and somewhat improved by R. H. Tawney, another Englishman who was part of the Toynbee Hall group, and his 1926 Religion and the Rise of Capitalism stands as the exemplar of this position. The Jews Werner Sombart (1863–1941) believed that the foundations of modern capitalism were to be found in the differences between Christian theology and Jewish ethics. The clearest articulation of this view is to be found in his 1915 The Quintessence of Capitalism, an economic development he seems mostly to have admired (at the time he wrote, prior to 1933) where there is a rather detailed exposition in an unusually sympathetic and admiring form of Jewish ethics as part and parcel of their religious core, an ethics based on a most un-Christianlike fear of a non-understandable-to-humans Almighty.18 Whether he changed his views or merely his tune after the Nazis took over remains unclear to me.19 Lujo Brentano The fascination with the role of religion on the evolution of capitalism came somewhat later into conflict with some disturbing facts. Lujo Brentano (1844–1931), also like Max Weber a professor in Munich, published in 1931 an autobiography (Brentano, 1931), describing not only his own career and ideas, but also the history of his distinguished Roman Catholic family. That family included bishops, but also a substantial number of business people living in Lutheran Germany. Brentano’s normal-economist’s cynical conclusion was that those who live in Lutheran territory were not only tolerated but honored if they were rich, even more so if they were very rich. Not so their impecunious fellows. True, the Jews were expelled from England in 1288, from Spain in 1492, and from many other places not only frequently but repeatedly, but at some point in time the economic advantages of tolerating their existence overcame the theological arguments about not having them around. That may not have been the sole cause for the development of capitalism – it may have been in part a result of the emergence of a capitalist mentality. Separating causes and effects particularly when applied to institutions is not easy. Yet, Brentano’s more general point, a version of Sophie Tucker’s legendary thought, “I have been poor, and I have been rich. Believe me, it’s better to be rich,” at the very least suggests that, quite aside from their religious convictions, avoiding being economically marginal at some point came to do much to offset the views that particular religious doctrines were essential to the evolution of modern capitalism.

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Economic development seen as distinct from the evolution of market capitalism Two writers, in particular, dominated the discussion of economic development in the late twentieth century literature: Joseph A. Schumpeter and his nemesis, Simon Kuznets. The former, his occasional denials aside, approached the topic from the standpoint of medieval realism; the latter from that of medieval nominalism. This essay, already too long by far, eschews the opportunity to describe their differences (such discussions can be found in M. Perlman, 2001). Schumpeter truly believed that a mathematical theory of dynamic general equilibrium could possibly predict, but certainly explain, the “fourth” dimension, namely the impact of knowledge as only time can reveal it on economic systems. However, Schumpeter was also well aware that he lacked the mathematical skill to implement his vision of that “fourth” dimension. He “sensed” at the end of his posthumously-published 1954 History of Economic Analysis that his student, Paul Samuelson, quite likely held the key to that locked goal. Schumpeter’s two efforts, the 1911 Theory of Economic Development and his 1939 Business Cycles, were critically and negatively reviewed by Simon Kuznets, first in a 1923 Master’s Essay submitted to Columbia University and in a slashing review of the 1939 study in a 1940 essay in the American Economic Review. In his 1954 Presidential Address to the American Economic Association, Kuznets (1955) reaffirmed his as yet unfilled hope that a general theory of economic development could be found. His own and others’ research efforts, based in large part on a detailed knowledge of the literature and even more on the detailed examination of such national product, national capital accumulation, and national income distribution data that he and they could find (and insofar as could be checked), had not matured to the point of anything like a “short-cut to understanding” (his phrase). Indeed, he took particular umbrage at Walt Whitman Rostow’s efforts to use his work as the authority-foundations upon which Rostow had based The Stages of Economic Growth (1960).

Conclusion Like Hamlet I believe that there is more to synthesizing the roles of culture, technology, and known resources than all our knowledge of analytics has given us. Modern market capitalism with its culture of greed and indifference to a widening disparity of family incomes seems currently to be the popular rage. Let me close, however, by saying that “popular enthusiasms” are not necessarily the real stuff from which historical trends are observed, particularly ex post, and I end this essay with two pleas. First, modern (meaning post–1980) literature has much to offer, but it surely cannot replace a century of previous studies; they too beg to be read. Second, I truly believe that an increment of additional capacities to synthesize is likely to be more valuable at this point in scholarly time than an additional capacity to refine economic analysis.

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Notes 1 My quondam colleague, Professor Alvin Roth, once pointed out to me that the question of who first discovered America remains open; but after Christopher Columbus America remained discovered. Similarly, after John Bates Clark the distinction between statics and dynamics remained discovered. 2 My thought is that what Viner found most disagreeable about Wisconsonian Institutionalism was its focus on synthesis rather than on analysis. For Viner the source of truly sound “scientific” economics could only be Cartesian analytical theory. 3 The new department chair, James Waterhouse Angel, changed the custom at the last minute and substituted George Stigler for Clark as my examiner. I was told that the other examiners thought Stigler too brutal. About 14 months later he reexamined me, but by then I was prepared. In time he advised Milton Friedman to appoint me as the founding Editor of the Journal of Economic Literature. Nicholas Balabkins has a story that Gustav Cassel once told Gunnar Myrdal to be more polite to his professors since they would be the ones to place him. In reply, Myrdal grumbled that they should remember that he would write their obituaries. 4 It was also the aspect that irritated Frank Knight when he criticized Wisconsonian Institutionalism as being so open-ended that it could mean anything or nothing. When I returned to Madison after my military service I decided to resurrect the moribund John R. Commons Society. My plan involved the graduate students inviting visiting speakers to address our group at a dinner meeting. The speakers’ expenses as well as the costs of the meals were divided amongst us members. Frank Knight was the first invitee (probably July 1946). My recollection is that Ed Witte was terribly bored (actually asleep), but Selig Perlman answered Knight’s criticisms mostly by saying that Knight, in failing to grasp the significance of knowing empirical records, was too enchanted with Medieval Realism, a situation that Perlman thought any number of theologians besides Aquinas had handled quite imaginatively. Given Knight’s known views toward the Roman Church, Perlman’s point sort of floored Knight – Knight merely gasped, and no reply was forthcoming. 5 Not least among these was protection from the ravages of old-age poverty. When as a soldier in World War II, I had read and thoroughly condemned Hayek’s Road to Serfdom (1944), my father wrote back that I had missed one essential hangover from the Scholastics’ Just Wage and Just Price – namely Hayek’s endorsement of a nationalized social security program. Later, when I endorsed Barbara Wootton’s Freedom under Planning (1945), he questioned who was going to enforce a wages policy on unions when great profits were being made. In short, studying with him had its startling (and wonderful) surprises. 6 He can be easily compared to Henry George in the sense that both were bitterly scorned by most academics who at the same time came to consider their principal ideas (without attribution, of course) quite seriously. 7 Hobson had enough appeal for the “unlettered middle classes,” that even such worthies as Alfred Marshall felt a need to bestir themselves to issue “epistles to their faithful” outlining (with apparent difficulty) the flaws in Hobson’s research and reasoning. 8 Apparently Hobson was unaware (according to a personal conversation I had with Lionel Robbins in 1977 about his contacts with Hobson) that Lenin had “pinched” his definition of imperialism when Lenin wrote Imperialism, the Highest Stage of Capitalism (1917). 9 Rightly or wrongly, Hobson’s definition was later used by the Soviets to describe America’s program “causing the Cold War,” while the West (meaning America and its allies) thought that nationalistic defensiveness explained Soviet imperialist moves. I presume that were Hobson alive today, he would argue that the American program of globalization of product and factor markets is exactly what he meant.

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10 By the 1916 edition he emended his treatment to incorporate the ideas of Werner Sombart about the German experience. 11 Alfred Marshall’s Industry and Trade (1920b) takes up this aspect such that his treatment becomes Hobson-writ-large. 12 Among the best known are the Village Labourer (1911) and the Town Labourer (1917). 13 Toynbee (1852–83) was academically an economic historian and personally very much interested in the problems of the poor, particularly the East End London Poor. Shortly after his death, friends and admirers established in the East End Toynbee Hall, a university establishment in Whitechapel, where inter alia university-type extension lectures for manual workers were regularly given to improve their intellectual lives. Toynbee Hall became well known as the focal point for those interested in spreading university learning to the masses. Among those was R. H. Tawney, whose work will be discussed shortly. 14 These Indians, generally the sons of the Maharajah class, were intended to absorb the mores, including the culture, of English “gentlemen.” 15 Disraeli’s novels Coningsby and Sybil portrayed the social responsibility theme that their author proposed as the “new” social reform message of the Tory Party. 16 The purported purpose of the Banca Monte dei Paschi, founded in Sienna in 1472, was to aid charity and education. The evident reason for its founding was a realization that the local Jewish moneylenders were enjoying too good a fortune. 17 Financial trading at a particular spot, “Banco” (on Venice’s Grand Canal), was forever memorialized as the name of the principal capitalist institution. 18 As I read that 1915 treatment, his assessment of the role of Jewish ethics is the closest to the essentially Jewish view of the topic by a non-Jew that I know. My scholarly father-in-law, Professor Meyer Waxman, eventually published in 1958 Judaism: Religion and Ethics, the very title of which stresses that the heart of Judaism is its ethics. (The Pentateuch, whether the literal truth or simply a long series of tales involving moral paradoxes, focuses almost entirely on discussion of Godly ethics, particularly as “revealed” in the later of the Five Books of Moses and then discussed in the Talmudic and eventually the Agadic writings; the traditions came along later.) 19 The great bulk of the printed matter suggests he wrote according to the Nazis’ racial lines, but Professor Juergen Backhaus (University of Erfurt), who has made a very detailed survey of these things, thinks that he did only what could be considered the very minimum along that line. There is also the additional fact that he moved quickly to dissolve the Verein für Sozial Politik, which had worked to advise governmental bureaus and other instruments on how to improve socio-economic programs. Thus it was that the archetypical German professional academic was, according to many German academics, effectively spared from being tarred with the Nazi brush.

References Brentano, L. (1931) Mein Leben im Kampf um die soziale Entwicklung Deutschlands (Jena: Diederichs). Hammond, J. L. and Hammond, B. (1911) The Village Labourer, 1760–1832 (London: Longmans, Green). Hammond, J. L. and Hammond, B. (1917) The Town Labourer, 1760–1832 (London: Longmans, Green). Hammond, J. L. and Hammond, B. (1926) The Rise of Modern Industry (New York: Harcourt Brace). Hayek, F. A. (1944) The Road to Serfdom (London: Routledge & Kegan Paul).

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Hobson, J. A. (1916) The Evolution of Modern Capitalism, revised edition (London: Walter Scott). Hobson, J. A. (1938) Confessions of an Economic Heretic (London: George Allen & Unwin). Hobson, J. A. and Mummery, A. F. (1884) The Physiology of Industry (London: John Murray). Keynes, J. M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). Kuznets, S. (1940) Schumpeter’s Business Cycles, American Economic Review, 30, pp. 257–271. Kuznets, S. (1955) Economic Growth and Income Inequality, American Economic Review, 45, pp. 1–28. Lenin, V. I. (1917) Imperialism, the Highest Stage of Capitalism (New York: International Publishers). Marshall, A. (1920a) Principles of Economics, 8th edition (London: Macmillan). Marshall, A. (1920b) Industry and Trade, 3rd edition (London: Macmillan). Mitchell, W. C. (1967) Types of Economic Theory, Vols I and II, ed. J. Dorfman (New York: A. M. Kelley). Perlman, M. (1958) Labor Unions in America (Evanston: Row, Peterson). Perlman, M. (2001) The Two Phases of Kuznets’ Interest in Schumpeter, in J. Biddle, J. B. Davis, and S. G. Medema (eds), Economics Broadly Considered: Essays in Honor of Warren J. Samuels (London: Routledge). Perlman, S. (1936) The Principle of Collective Bargaining, Annals of the American Academy of Political and Social Science, 184, pp. 154–160. Rostow, W. W. (1960) The Stages of Economic Growth (Cambridge: Cambridge University Press). Schumpeter, J. A. (1911) Theory of Economic Development (New York: Oxford University Press, 1985). Schumpeter, J. A. (1939) Business Cycles: A Theoretical and Statistical Analysis of the Capitalist Process (New York: McGraw-Hill). Schumpeter, J. A. (1954) A History of Economic Analysis (New York: Oxford University Press). Sombart, W. (1915) The Quintessence of Capitalism (New York: Dutton). Tawney, R. H. (1926) Religion and the Rise of Capitalism (London: John Murray). Toynbee, A. (1884) Lectures on the Industrial Revolution in England (London: Longmans, Green). Waxman, M. (1958) Judaism: Religion and Ethics (New York: Yoseloff). Wootton, B. (1945) Freedom under Planning (London: George Allen & Unwin).

11 Aggregate demand, employment and equilibrium with marginal productivity Keynesian adjustment in the Craft Economy Edward J. Nell

Ingrid Rima always approached the idea that marginal productivity accounted for the demand for labor with caution and skepticism, more so than Paul Davidson (1994) and Victoria Chick (1983). None of them, however, thought that the account was illuminating or that supply and demand for labor determined employment and real wages. But while Rima insists that the behavior of the labor market is chiefly determined by institutions, Davidson and Chick have tried to accommodate Keynes’s insistence that the real wage did equal the marginal product of labor, even in less than full-employment equilibrium. All agree that Keynes’s approach recast the argument in money rather than real terms, rejecting the Classical Dichotomy. But if the market operates with money wages, how is the real wage adjusted to the marginal product? If the real wage adjusts in the labor market, why is full employment not established? And when there is unemployment in “equilibrium,” why is it so deep and persistent? Keynes repeatedly insisted that his argument proceeded to establish less-thanfull-employment equilibrium “. . . without disputing the vital fact which classical economist have rightly asserted . . . that the real wage has a unique inverse correlation with the volume of employment . . . This is simply the obverse of the familiar proposition that industry is normally working subject to decreasing returns” (1936, p. 17). Post Keynesian interpreters contend that this implies that the marginal product curve shows positions of market equilibrium.1 This could be argued if prices generally were equal to marginal costs, as Keynes seems to have supposed (with marginal costs rising). A suggestion can be found in Keynes’s lectures of 1932–35 (Rymes, 1989). On p. 137, starting from the expression giving employment as a function of expected sales proceeds, Keynes proceeds to derive an equation showing price equal to the wage bill times a markup expression divided by output. Under competitive conditions (with appropriate further assumptions) this would show price equal to or proportional to marginal cost, which would imply a corresponding relationship between the real wage and the marginal product of labor. But while a discrepancy between the real wage and the marginal product, under competitive conditions, can be

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considered a disequilibrium, the market movements to correct this are not spelled out. It is necessary to show how the equilibrium can be reached by market processes, given that labor will respond only to money wages. This is not easy to find in the literature. However, a simple diagram can help, though it will take some explaining. To develop it we will start from the assumption of given plant and equipment, operating under diminishing returns to additional employment of labor (what Joan Robinson, 1956, called a “utilization function”). Initially we will take the money wage as given. But to explain in what sense, we will have to explore Keynes’s conception of the labor market.

The marginalist account of the labor market When the General Theory was first published, many commentators, for example, Franco Modigliani (1944) and Lawrence Klein (1947), simply assumed that the marginalist account of the labor market was broadly accurate, provided wages and prices were flexible. But Keynes was correct, they argued, to note that, as a matter of fact, money wages (and prices) are often not flexible – for reasons which the early Keynesians did not explore very deeply. New Keynesians have since advanced an array of carefully developed theories to account for this – acknowledging and modeling imperfect markets and coordination failures (monopolies, oligopolies, unions, menu and transaction costs, bounded rationality), examining explicit and implicit labor market contracts, “insider” markets and “efficiency wage” systems, and exploring the effects of asymmetric risk aversion and asymmetric information in credit (and other) markets. Starting from utility-maximizing households and profit-maximizing firms, with Walrasian markets and the usual forms of rational economic calculation, New Keynesians have shown that introducing these plausible and largely realistic imperfections and limitations will result in price and wage rigidities that yield involuntary unemployment and other Keynesian conclusions. In the light of history there is something very odd about this. In the late nineteenth and early twentieth centuries, both prices and money wages were flexible. That is, in response to variations in demand they both rose and fell, although prices were markedly more flexible in both directions than wages. (And both were more flexible than output and especially employment, with the result that higher levels of output and employment were statistically associated with lower real wages (Dunlop, 1938; Tarshis, 1939; for recent studies, Nell, 1998a, 1998b). Yet during this period, when prices and wages were flexible, virtually all the imperfections canvassed above were substantially more widespread and more severe than in later periods when they are supposed to account for rigidity! The standard Keynesian model takes the money wage to be fixed, so that the system is in a kind of institutional disequilibrium – the labor market cannot do its job, because there will be no proper labor supply function. Supply and demand do not operate as they normally would. Yet if that is so it may seem unclear why the real wage should end up being equal to the marginal product of

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labor. All parts of the model interact, but what exactly brings the real wage and the marginal product to this position if the money wage cannot move? If the money wage is allowed to be flexible will that affect how marginal productivity adjusts? If wages are flexible there will be a labor supply function, so the market will work as it “should.” This is the position taken, for example, by Modigliani.2 By contrast, Keynes’s position – and that of most Post Keynesians – is that the starting point, the marginalist labor market, is simply not a correct account of wages and employment. The employment of labor and the setting of wages are not brought about through the functioning of a market in the marginalist sense – that is, a market in which the wage reflects productivity at the margin on the one hand, and the disutility of additional effort on the other. In such a market, in which behavior is governed by costs on both sides, we might expect effort to be allocated optimally if other appropriate conditions are met; to define such a market, to serve as the norm or standard, is presumably the neoclassical project. But, according to Keynes, the labor market does not and cannot function that way. The wage, he argues, does indeed reflect the marginal productivity of labor, but it does not and cannot reflect its marginal disutility. There is no adjustment mechanism, no way that the real wage could be brought into alignment with the marginal disutility of labor. Labor could accept or reject a money wage; but they could do nothing about prices, nor could they reliably know whether prices would be stable or changing in the near future.3 Keynes objected not only to the marginalist labor-supply function, but most importantly to the idea that employment and real wages (and so output) were determined in the labor market. Labor supply depends on people needing jobs, and can be taken, in the short run, as an institutional datum, influenced to changing degrees by many factors. Money wages may have an influence; so may prices. So may the availability of jobs. These factors may be affected in unpredictable ways by non-economic matters. The labor market will influence only money wages, while the product market will affect prices, and adjustment will take place through the interaction of all parts. In short, he argues that a marginal product curve can be defined, but not a supply curve based on relating disutility of labor to the real wage. Yet he does not explain how the real wage is brought and kept equal to the marginal product. Nevertheless, he argues that the economy will tend to equilibrium, in the sense that the real wage will equal the marginal product of labor, thus maximizing profits, even though the economy typically reaches a position of less than full employment. Most significantly, he argues that fluctuations due to changes in investment spending will be amplified – consumption will move in the same direction as investment. How can these points all be brought together? To what extent do they depend on relating behavior and choice to money variables, rejecting the Classical Dichotomy? The argument here will be an extension of the Keynesian position, starting from the idea that the labor market works differently under different technologies, because costs are different. The suggestion here is that technology governs the behavior of costs, and that the behavior of costs determines whether and to

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what extent prices and wages are flexible – and, indeed, may generate market incentives to change that flexibility. A brief sketch outlining this view might help. Two technologies will be considered, one which can be labeled “Craft-based” or “Marshallian,” in which small enterprises employ skilled work teams, and in which it is difficult and costly to vary output or employment. The other is “Mass Production,” in which output and employment are easily and rapidly adjusted to variations in sales, and variable costs tend to be constant over a wide range of output levels. It will be argued that neither allows for a labor market in which there will be an adjustment process that would tend to move the system towards a position in which all labor seeking jobs will find employment at a determinate wage. This chapter will first explore the adjustment of employment and wages in the Craft or Marshallian Economy, and then consider adjustment in a Mass Production system. A Marshallian technology will show clear diminishing returns to employing additional labor with given plant and equipment. But this is an unsatisfactory technology, and firms will try to gain greater control over costs, leading eventually to a flattening of the employment–output function, until it becomes a straight line, indicating constant returns. In the Marshallian Economy both wages and prices are flexible, but prices are more flexible than wages – the proportional deviations are greater – and both fluctuate more than employment. This is because production is based on a technology of skilled craft workers; production teams must work together; their ability to function together is part of the “embodied” capital of the firm – breaking them up will be a capital loss. Plus start-up and shutdown costs are high. Hence only inessential workers can be laid off. Thus demand fluctuations will be met by slowing down production somewhat, but not reducing employment much. Profits will bear much of the burden of slower sales, providing an incentive to firms to gain better control over their costs. This they will do by increasing their capital investment and mechanizing. This will make it possible to vary output and employment together over a range, with unit running costs staying constant.

A model with Marshallian technology and Keynesian wages It is possible to write a set of equations related to traditional interpretations, e.g., Modigliani’s system, but which, arguably, will be closer to Keynes (see Nell, 1998a, Ch. 12, part I). In this interpretation of Keynes the behavioral equations are written in real terms, so there is no possibility of money illusion. Furthermore, while the real wage is equal to the marginal product of labor in general, the real wage and employment are not determined in the labor market. They emerge from the entire system (see Keynes, 1936, Ch. 2; Rymes, 1989). Instead prices and demand are determined in the product markets, and employment adjusts to demand. Two cases are considered: in the first, money wages are given; in the second, they are influenced by the level of employment in relation to full employment.

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Y  Y(N, K*)

(1)

w/  Y/N  Y(N)

(2)

C  (w/)N

(3)

I  I(i, C), Ii  0, IC  0

(4)

M/  L(i, Y), Li  0, LY  0

(5)

YCI

(6)

Y  (w/)N  P

(7)

w  w*

(w* is rigid or fixed)

w  F(N N*)

(8a) (8b)

where Y is aggregate income, C is aggregate consumption, I is investment spending,  is the price level, N is the level of employment, M is the money supply, I is the interest rate, w is the money wage, and P is aggregate profits; w* is the normal or initial level of the nominal wage, and N* is full employment.4 A thought experiment will shed some light on the idea of flexible money wages and prices: suppose that the money wage is determined by equation (8b). A lower money wage will require a lower price level to sustain the same real wage. But M is fixed; with lower prices, there will be lower transactions demand, requiring a lower rate of interest to absorb the money supply. The lower rate of interest will mean higher investment demand, implying higher N, and a lower real wage. This is to some extent offsetting – there is no reason to think that a decline in money wages proportional to unemployment would lower transactions demand, and so the interest rate, enough to generate the investment demand needed to move to full employment. Perfectly flexible money wages, on the other hand, would be different. In that case, a small amount of unemployment would bring about an indefinitely large decline in money wages. In that purely artificial case – if prices followed suit immediately – then the transactions demand would fall towards zero, bringing the rate of interest down to the liquidity trap level. Then, depending on the elasticity of I with respect to interest, the economy would tend towards full employment. But moderately flexible money wages would not necessarily move the economy towards full employment. However, to see this clearly we need a reasonable account of how these pressures come about, and how they drive the adjustment to the point where the real wage equals the marginal product of labor. This can be done by assuming that the technology is “Marshallian,” that is, that craft labor can be applied to given equipment in the short run, resulting in diminishing returns, as in Marshall’s account.

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The price mechanism and Marshallian technology5 The principles underlying the Craft Economy center on the short-run employment–output relationship.6 In the Craft Economy (Nell, 1998a, 1998b), we can reasonably assume diminishing returns to the employment of labor, in relation to a normal position. Adding extra workers to work teams operating given equipment brings progressively lower rewards, while removing workers leads to progressively larger losses of output. In general, it will be difficult to adjust levels of employment. Workers cooperate in teams that cannot be lightly broken apart or added to; all workers have to be present and working for a process to be operated at all; processes cannot easily be started up and shut down. So the Craft Economy not only has diminishing returns, it also has inflexible employment (Nell, 1998a, Ch. 9).7 The model is based on such an aggregate function, given as equation (1) above, where a conventional shape and properties have been assumed. This is appropriate for a Craft Economy8 where output increases with labor according to a curved line that rises from the origin with a diminishing slope (by contrast, Mass Production will be characterized by a straight line rising from the origin).9 As a first approximation consumption can be identified with wages and salaries,10 while for the purpose of drawing the diagram investment can be taken as exogenous. As employment rises, the wage bill, and so consumption spending, will rise at a constant rate, namely the normal wage rate. Total expenditure will then be shown by adding investment to the wage–consumption line. Figure 11.1 presents the aggregate utilization function, with output on the Y

CI Y  Y(N) Y0 Y1 I0 I1 W1

wN  W  C

W0 N 1'

N1

N0

Figure 11.1 Adjustment in the Craft Economy.

N

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vertical axis and labor employed on the horizontal. The function of the Craft Economy is curved, its slope falling as N increases (the Mass Production line would rise to the right with a constant slope). The wage bill (including salaries) will be assumed to be equal to consumption spending (transfer payments could be included also). There is no household saving and no consumption out of profits, but both assumptions are easily modified.11 So the wage bill, also representing consumption spending, is shown by a straight line rising to the right from the origin; its angle is the wage rate. Investment spending will be treated as exogenous in the short run, so will be marked off on the vertical axis. Aggregate demand will then be the line C  I, rising to the right from the I point on the vertical axis; its slope is the wage rate.

Adjustment to demand fluctuations in the Craft Economy Suppose investment is unusually low, below normal, so that this line cuts the utilization function at a point below the normal level of output and employment, N1. Since it is difficult to adjust employment and output, there will tend to be overproduction, and prices will fall. Since it is even harder to adjust employment than output, prices will fall more readily than money wages. Hence the real wage will rise, from w0 to w1. As a result the C  I line will swing upwards, until it is tangent to the utilization function; employment thus settles not at N1 but at N1. Notice that this point of tangency will tend to be close to the normal level of employment and output, and will be closer the more concave the function. In short, when investment is abnormally low, the real wage will rise; if the rise in real wages is proportionally greater than the decline in employment, consumption will increase. Conversely, suppose investment were exceptionally high, or that the C  I line had too steep a slope, indicating too high a real wage. In either case, expenditure would lie above output at any feasible level of employment. Under these conditions prices would be bid up relative to money wages, and the C  I line would swing down, until it came to rest on the utilization function in a point of tangency (Nell, 1998a, pp. 455–457). Again this point would tend to lie close to the normal level, being closer the more concave the function. When investment is unusually high, consumption will tend to adjust downwards. Notice that adjusting the real wage to equal the marginal product of labor both assures a unique equilibrium and maximizes profit.12 When the C  I line is tangent to the utilization curve the distance to the wage line is at a maximum; if C  I cuts the utilization curve, there will be two equilibria and the distance between the intersection points and the wage line will be less than that at the tangency. (Given the real wage, profit rises with employment at a diminishing rate from the origin to the tangency point; it then falls at an increasing rate until it reaches zero at the point where the production function intersects the wage line.) We need to define the point of full employment – the point at which the entire labor force has jobs. An appropriate concept of full employment would be “no

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WC P

MaxP P

I

N*

N

Figure 11.2 Behavior of profits.

vacancies” or, rather, “no vacancies except turnover vacancies.” Employment is full when all farms, factories, offices, and shops have hired the employees they need to operate at their optimal level. Output at the point of full employment will be associated with a marginal product; that marginal product will become a real wage, which multiplied by the level of full employment defines the wage bill, equal, ex hypothesi, to consumption. The difference between full-employment output and consumption must be filled by investment. Now let investment fall below this full employment level. As it does, it will trace out the marginal product curve; at each lower level of investment, prices will fall, and the real wage rise, while employment falls; the overall effect on consumption will depend on the elasticity of the marginal product curve. But each point on the curve will be an equilibrium, in the sense that money wages and prices have adjusted to produce the profit-maximizing position. That this pattern of price flexibility dampens fluctuations by partially offsetting them, in conditions of strongly diminishing returns, can be shown very simply. Recalling our equations: Y is real output, N employment, w/ the real wage, and I investment. All wages are consumed. As above, Y  Y(N), Y  0, Y  0 YCI w/  Y(N)

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C  (w/)N Clearly Y  I  (w/)N, so dY/dII/IN[(w/)/I](w/)[N/I]1N[(w/)/I](w/)[N/I] where N[(w/)/I]  0 and (w/)[N/I]  0. So dY/dI  or  1 according to whether N[(w/)/I]  or  (w/)[N/I].13 So long as returns diminish sufficiently dY/dI  1; price changes due to variations in investment demand will lead to a partial offset.14 In short, so long as diminishing returns are significant the price mechanism will lead consumption to adjust so that it will tend to make up for a shortfall or offset an excess of investment. It thus tends to stabilize demand around the normal level of output and employment. This form of adjustment brings to mind the doctrine of “forced saving” (Thornton, 1802; Robertson, 1926; Hayek, 1933). Here, however, the price changes are assumed to reflect changes in demand pressure – not necessarily connected to changes in the quantity of money – and are shown to result in a Marshallian “marginal productivity” equilibrium.15 The traditional “forced saving” discussion usually started from an assumed increase in the money issue or in an exceptional extension of credit, and, indeed, a rise in demand of the kind considered here would require just such additional finance, which the resulting rise in prices relative to money wages would tend to support. (The higher profits will allow banks to charge higher interest rates, enabling them to attract additional reserves. The higher interest rates, however, should tend to dampen further expansion.16) This shows that there is good reason to expect adjustment to bring about a real wage and a level of employment, such that the real wage will be equal to the marginal product of that level of employment – which need not be full employment. So let’s return to model and work through it, starting with the solution when we have a fixed money wage. An instructive informal approach: set the investment function equal to profits, in effect setting out an analogue to the conventional IS curve. This combines equations (4), (6), and (7) with (1), (2), and (3), yielding a relationship between i and N, based on the equality of I and P. Then equation (5) can be combined with (1) and (2), to form another function relating i and N, based on the equality of M and liquidity demand. But since equation (2) is drawn on in constructing both, equation (8a) must be used to set the money wage at the fixed level. Then these two relationships can be solved for i and N, and the results (which will depend on the form of the functions17) substituted back to establish the equilibrium values of the other variables. All the markets interact, but there is no reason to expect full employment. Now let’s turn to the second case, replacing the fixed wage equation with flexible money wages, equation (8b). This states that when there is unemployment money wages will fall, with the decline proportional to the rate of

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unemployment. Given that unemployment reflects lower demand, we can expect that prices will also fall, but prices will have to fall further, in order for the wage bill to rise enough for there to be an offset to the lower demand. If there is no offset then the fall in money wages could reduce the real wage, and make unemployment worse than if money wages had been rigid. Next I propose to deal more fully with the financial market by allowing for arbitrage between equity and bonds.18 The Modigliani–Miller Theorem argues that arbitrage ensures that bonds and equity are perfect substitutes. The proposal here is much less extreme; it just asserts that there will be market pressures to pull the current rate of profit and the rate of interest together, in circumstances where the Central Bank is not pegging. P/K  [Y (w/)N]/K  i,

(8c)

where  is a parameter representing risk and the “equity premium.” This has the effect of fixing the interest rate, but because we have dropped (8a), it leaves the money wage as a variable, although we have not specified an equation to govern it. It will simply be determined as a residual – for the moment. The result is quite striking: a version of the Classical Dichotomy reappears, but there is no reason to expect full employment. An informal argument can support this as follows: Start with (4), the investment equation, I  I(i, C) and eliminate i and C on the right-hand side, by substituting into it, using the production function (1), the real wage equation (2), consumption (3), and the income equation (7). In this way eliminate the other variables until only N and coefficients remain. Note that to remove the interest rate, i, equation (8c) will have to be used. (When the model rested on (8a), fixed wages, the interest rate could not be removed from the investment equation (4) without drawing on the monetary equation (5); monetary and real parts of the economy interact.) Next use equation Y  C  I to replace I on the left-hand side, and then draw on equations (1), (2), and (3) to reduce every expression to a function of N. Then solve for N, and substitute back. From equation (1), we find Y; from (2), w/; from (3), C; from (6), I. Then with I and C, the interest rate, i, will follow from equation (4). Finally, equation (8c) yields P, profits. Thus the seven equations pertaining to savings–investment and output–employment determine the seven real variables: N, Y, C, I, P, i, and w/. Equation (5), for the money market, is left to determine , the price level, which will then give us the money wage from equation (2). So real relationships determine real variables and monetary forces affect only nominal variables! But to leave the money wage simply drifting, determined residually, cannot be allowed, given the intense market (and non-market!) pressures on money wages. However, we can turn to equation (8b) which models the pressures on

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the money wage. Yet adding this equation, too, would appear to overdetermine the model. The natural response would be to allow for a flexible money supply, so that M becomes a variable that will adapt to the pressures of the market. This can be allowed to drift, for that simply says that the authorities will accommodate. Thus a version of the Classical Dichotomy can be derived, with the real wage equal to the marginal product of labor, although the model is demanddriven, and need not reach equilibrium at full employment.19 The importance of money here lies in the fact that wages are paid in money, and prices charged in money. Labor never faces real wages in the market; it can only react to the money wage, which means that supply and demand in the labor market cannot determine employment and the real wage, as mainstream economics has held. The mainstream system pretended that markets adjusted in response to real variables, whereas in fact adjustments necessarily take place in response to money variables. Worse, the traditional approach assumed that the economy always operated at full employment. This was unjustified. But rejecting the Classical Dichotomy by itself did not explain either unemployment or why the depression of the 1930s was so severe. Equilibrium was possible at less than full employment because employment was determined by aggregate demand, not in the labor market. But this still did not explain why the depression was so deep. That became clear with the understanding that changes in investment led to changes in consumption in the same direction – the idea behind the multiplier. When investment fell, consumption also fell. This was why the fluctuations were so serious. And this is consistent with the real wage adjusting to equal the marginal product of labor; so there is a profit-maximizing equilibrium, one among many possible, even though full employment may not be reached and the swings may be severe. When the curvature of the production function is considerable, the elasticity of the marginal product curve will be greater than 1, so a fall in investment will lead to a rise in the wage bill and therefore in consumption spending, as shown in the diagram. But when the production function is rather flat, the elasticity of the marginal product curve will be less than 1, so that a fall in investment will lead to a decrease in the wage bill and consumption spending, as shown in the diagrams. In this case there is not only no offset to the drop in investment – the effects are actually made worse. And that is the conclusion Keynes reached and tried to explain in the lectures he gave in Cambridge. The variability of profits provides an incentive to change the technology so as to control current costs; the innovations must change current costs from fixed to variable; this will be done by increasing capital costs. Consider a Samuelson surrogate production function, with pressures for w to increase: at the higher wage it is worthwhile to mechanize, so in current prices capital per worker rises, and the scale effects allow for greater flexibility in adjusting employment to changes in the level of demand.

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The multiplier replaces the price mechanism Fluctuations in I will normally have some impact on N even in a Craft Economy. But there will be an offsetting movement in C so long as the curvature of the employment function is large. The price mechanism is stabilizing for the system as whole, but the effect is that profits fluctuate sharply for individual businesses. So firms will be motivated to redesign their production systems to allow greater flexibility in adapting to demand fluctuations. This means being able to add on or layoff workers, without greatly disturbing unit costs. As such redesigning takes place, it will reduce the curvature of the employment function; that is, diminishing returns will be lessened. We can think of this as a progressive flattening of the employment function. When this has reached the point where the marginal product curve has unitary elasticity, so that the proportional change in the real wage is just matched by that in employment, then the total wage bill is unaffected by the price changes following the change in I. If the total wage bill is unaffected, then, on the assumptions made earlier, total C will be unchanged. This will be the case, for example, when the employment function takes the form: Y  A(ln N). Hence I may fall, for example, but C will not change. There will be no offset. So dY/dI  1. Any further reduction in the rate at which returns diminish will mean that the change in employment will outweigh the change in the wage bill, so that C will move in the same direction as I. In this event dY/dI  1 will always hold (Nell 1992; 1998a). It can be argued that this was the conclusion that Keynes seems to have been seeking. In his Second Lecture in the Easter Term 1932, Keynes reached “the remarkable generalisation that, in all ordinary circumstances, the volume of employment depends on the volume of investment, and that anything which increases or decreases the latter will increase or decrease the former” (CW, XXIX, p. 40; see also Rymes, 1989, pp. 30–44). The “Manifesto” written by Joan Robinson and Richard Kahn, with the concurrence of Austin Robinson, challenged not the result, but the reasoning used in reaching it. As noted above, part of their discussion concerned the effects of price changes on demand. Rymes notes, “The ‘manifesto’ claimed that the case of no increase in the demand for consumption goods [following an increase in investment spending] was the one exceptional case Keynes had dealt with . . . It is . . . an obviously special case.” On the assumptions here it is the case where the elasticity of the marginal product curve is unitary. Both Keynes and the “manifesto” authors considered the “elasticity of supply” to be a determining factor, but neither presents a precise analysis.

Adjustment to demand fluctuations in the Mass Production Economy Modern economies appear to be subject to strong fluctuations in demand. Indeed, examples of market instability can be found everywhere, although the instability is usually bounded in some way. But there do not appear to be, in the

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modern world, strong and reliable market-based forces ensuring stability. Investment spending appears to be a major source of demand variation. Yet if the purpose of investment were simply a corrective, moving the actual capital/labor ratio to its optimal level, stabilization would hardly be needed. Such a long-run position would be stationary, or, if the labor force were growing, the economy would expand uniformly. This is the picture presented by neoclassical theory, articulated, for example, by Hayek (1941). But both Keynes and the older classicals, especially Ricardo and Marx, offer a different view: investment is the accumulation of capital, a process by which productive power is created, organized, and managed. It is driven by the desire for power and wealth, and there is no definable “optimum.” Investment expands productive power, but does not move the economy towards any definite destination. Given such motivation and the important role of technological innovation, the urge to invest will sometimes be strong and widespread, but at other times weak and uncertain. This may help to explain the need for stabilizing policies, arising from the demand side. In post-war Mass Production economies, prices do not play an important role in adjustment to changing demand (Nell, 1998a). Employment is much more flexible, and constant returns appear to prevail in the short run; to put it differently, unit costs are broadly constant as employment and output vary over a wide but normal range. Workers need only be semi-skilled and teams can easily be broken up and re-formed; processes can be operated at varying levels of intensity in response to variations in demand, and they can easily be shut down and started up. It is likewise easy to layoff and recall workers. As before we have an aggregate utilization function: here the Mass Production Economy will be characterized by a straight line rising from the origin, showing constant marginal returns. As a first approximation consumption can be identified with wages and salaries, while investment can be taken as exogenous. As employment rises, the wage bill, and so consumption spending, will rise at a constant rate, namely the normal wage rate. The wage bill, assumed equal to consumption spending, is represented by a straight line rising to the right from the origin; its angle is the wage rate. Investment spending will be treated as exogenous in the short run, so will be marked off on the vertical axis. Aggregate demand will then be the line C  I, rising to the right from the I point on the vertical axis; its slope is the wage rate. The origin, here and in later diagrams, is the point at which labor cost absorbs all output. Employment in such an economy will depend only on effective demand; there is no marginal productivity adjustment.20 Output will increase with the amount of labor employed (capacity utilized); all and only wages will be spent on consumption, and all profits will be saved as retained earnings. Investment can be taken as exogenous as a first approximation.21 Expenditure is given by the C  I line. (This ignores G, government spending, for the moment, although in the modern world it will be much greater than in the earlier forms of the capitalist economy.) But the output function will be a straight line rising from the origin with a slope equal to the average productivity of labor. Suppose

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C  I'

Yf

CI

Y*

WC

N*

Nf

N

Figure 11.3 Adjustment in the Mass Production Economy.

investment is exceptionally high; then employment will be increased, and consumption will also be exceptionally high. Conversely, if investment is low, employment will be low, and thus so will consumption. Consumption adjusts in the same direction that investment moves. When investment rises, consumption, output, and employment also increase in a definite proportion. Simple as this is, it provides us with a number of powerful insights. Admittedly, they are derived on the basis of very great abstraction, so they cannot be expected to prove literally true; but they may nevertheless give us genuine guidance in investigating the way the world works. For example: •

•

•

•

Investment and profits are equal here; this suggests that we should expect to find them closely correlated in practice – as we do (Nell, 1998a, Ch. 7; Asimakopulos, 1971). Investment determines profits here; investment is the driving force. We should expect to find something like this in reality, and many studies suggest that we do. The multiplier here will equal 1/(1 w/a), where w is the real wage and a is the output/labor ratio. That is, the multiplier will reflect the distribution of income, and will not be very large. Again this seems plausible. Real wages and the level of employment and output are positively related. This can be seen by drawing in a steeper wage line, with the same level of investment. The C  I line with then also be steeper; so it will intersect the output line at a higher level of output and employment. In fact most empirical studies of the post-war era do find real wages and employment to be positively related (Nell, 1998b; Blanchard and Fisher, 1989).

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•

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Household savings reduce output, employment, and realized profits! Obviously, qualifications are needed, and it must be remembered that this is a short-run analysis – but the long run may never come! If this proposition seems hard to accept, think about Japan in the 1990s, and even more recently. Unemployment is indicated by marking off the level of full employment on the horizontal axis. It clearly results from deficiency in demand. That is, either investment is too low or wages are too low, which implies that unemployment can be reduced by increasing either.

Finally, money: Let household saving increase with the rate of interest (as consumer durable spending declines), while business investment declines as the rate of interest rises. (Neither influence is likely to be very great.) More precisely, when interest is relatively high, businesses are likely to curtail or postpone investment projects, and households may cutback on consumer durables. Thus when interest is high the investment line must shift down to a lower intercept, while the household consumption line will swing down, reducing its angle. When interest rates are relatively low, investment and household spending will be correspondingly higher. Thus we can construct a downward-sloping function (an analogue to the traditional IS curve) relating the rate of interest, i, to employment, N. This function will intersect a horizontal line representing the level of the rate of interest as pegged by the Central Bank; this will determine the level of employment. There is no Classical Dichotomy here; monetary and real factors interact. Yet – not so fast! What about equation (8c)? If we impose this condition, the structure of asset prices will have to adapt to the real conditions of profitability, so the long rate will Y Y  aN CI C'  I' Y* WC P

C'

Y'

W I

N'

N*

Figure 11.4 Effects of interest on saving and investment.

N

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E.J. Nell i

N

Figure 11.5 The Central Bank’s interest rate determines employment.

tend at times to move independently of the short. A form of the dichotomy may re-emerge. But this is another story.

Conclusions Keynes accepted the idea that the price mechanism did adjust to ensure that the real wage equaled the marginal productivity of labor. He did not, however, explain how this equality was brought about in labor market in which behavior responds to money wages. In his view the equality of the real wage and the marginal product justified calling the position an equilibrium; but his argument shows that there will be a large number (on plausible assumptions, an infinite number) of such positions, besides the full employment level. The way this works can be shown on a diagram in which it is clear that price changes tend to move the system to a profit-maximizing position, for a given level of investment. But at first sight this appears to be a stabilizing pattern of adjustment. Each position of the economy will be a combination of a level of investment and a level of consumption (equal to the level of the real wage bill), such that higher investment (driving up prices, lowering real wages) would appear to be associated with lower consumption spending. This is stabilizing. When investment falls, for example, prices will fall, and consequently real wages and therefore consumption spending will rise, offsetting the decline in investment. But such a pattern of adjustment puts the burden on profits; prices would fall in a slump, and firms would have to draw down their reserves. Accordingly firms should seek to develop greater flexibility to allow them to adjust the level of employment to market conditions, laying off and rehiring workers as demand changed. This provides an important incentive to innovate (Nell, 1998a). Keynes did not examine this. But what he saw is that price adjustment was not working to stabilize the system. On the contrary, fluctuations in investment appeared to set off destabilizing movements. A key point of his lectures was to explain this, showing that investment and consumption moved together, not inversely, thereby increasing volatility. This is a consequence of reducing the

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rate of diminishing returns, flattening the production function. Furthermore, he argued that investment was the active variable, the causative force, while consumption (and saving) simply reacted passively. So prices and employment could adjust in such a way that the real wage and the marginal product of labor were brought into equality, thereby maximizing profits, while investment and consumption moved together, rather than inversely, creating multiplier-based volatility in the system. There is no pressure in this system to move to full employment, but each position can reasonably be considered an “equilibrium.”

Notes 1 Both Davidson and Chick show how aggregate demand and aggregate supply in nominal terms interact (following Davidson and Smolensky, 1964) to determine employment and nominal output. Changes in money wages and prices will shift these aggregate functions, and a money wage-employment curve can be defined. But no process is defined showing how real wages and marginal productivity adjust. 2 Modigliani and Hicks interpreted Keynes’s premise that the real wage would equal the marginal product of labor as implying that employment would be determined in the labor market, unless that market were prevented from working by some kind of “imperfection.” The claim here is that Keynes can be understood quite differently; it is consistent with his argument that prices could adjust relative to money wages, in order to bring the real wage into alignment with productivity at the margin. In this case there would be no “labor market” of the traditional type, but as we shall see such a system of price adjustment will tend to provide stabilization. (However – a point that Keynes certainly did not see – such a tendency to stabilize will be eroded as technology develops, since technological improvement will provide business with a greater ability to adjust employment and output to the variations in demand.) 3 Keynes always distinguished wage movements from price movements; wages and prices responded to different market pressures, so could adjust separately. Of course, they would also influence each other. But even over long periods they could move differently; accordingly, in the Treatise (1930), he distinguished wage inflation and profit inflation. 4 Neither Modigliani nor Hicks even considers the possibility of an equation like (8b), yet it seems to be suggested by Keynes’s discussion of money wages and prices. 5 Early capitalism, through the nineteenth century, appears to have had a weak built-in automatic stabilizer in a “price mechanism,” which depended on technological inflexibility, and moved countercyclically, in tandem with the monetary system. This was swept away with the advent of mass production, and replaced by a volatile pattern of adjustment, in the multiplier augmented by the accelerator (or capital-stock adjustment process), so that the system came to rely on Government for stabilization. This has been explored for six countries, the US, the UK, Canada, Germany, Japan, and Argentina, in which adjustment during the period 1870–1914 is contrasted with that in 1950–90. Evidence of a weakly stabilizing price mechanism is found in all six in the early period; the transition to a multiplier-based adjustment is apparent in all but Argentina, which did not seem to fully accomplish the transition to a modern economy during the period studied (Nell, 1998b). 6 This is a short-run relationship in which given plant and equipment is operated with more or less labor. Marshall and Pigou arguably operated with such a conception. A “true” production function (Hicks, 1963) would require changing the technique when the amount of labor per unit capital varied. This is not a viable conception, as the capital controversies showed (Laibman and Nell, 1977; Kurz and Salvadori, 1995).

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7 In post-war Mass Production, by contrast, constant returns prevail in the short run; to put it differently, unit costs are broadly constant (Nell, 1988, 1998a). Workers need only be semi-skilled and teams can easily be broken up and re-formed; processes can be operated at varying levels of intensity in response to variations in demand, and they can easily be shut down and started up. It is likewise easy to layoff and recall workers. The widespread existence of constant unit costs came to light beginning with the debate on prices and pricing in the 1930s and 1940s (cf. Hall and Hitch, 1938; Andrews, 1949). The suggestion here is that constant costs were the result of technological developments in manufacturing processes (Hunter, 1979). The evidence for constant costs is summarized and discussed in Lavoie (1992, Ch. 3). Under constant costs, of course, the real wage will not be governed by marginal productivity. 8 To move from individual firms to the aggregate it is not necessary to hold the composition of output constant, so long as the movements are small. In both Craft and Mass Production the adjustment is better shown in two sectors. The aggregate function oversimplifies. When proportions of capital to consumer goods change in the Craft world, prices change; when they change in Mass Production the degree of utilization changes, but unit costs and prices are not affected. 9 The Penn World Tables provide data making it possible to plot output per head against capital per head with a large number of observations. When this is done for the advanced OECD economies, the scatter diagram shows no evidence of curvature. The same plot for the backward economies exhibits pronounced curvature, for middle-range economies moderate curvature. Of course this can be considered no more than suggestive. 10 Wages and salaries in the aggregate are closely correlated with consumption spending, but do not fully explain it. Some obvious adjustments are easily made. Consumer spending also depends on the terms and availability of consumer credit. In addition it reflects transfer payments. Wealth and profitability are significant variables. But for the present purposes, which are purely illustrative, a simple “absolute income” theory will suffice. 11 This, of course, directly contradicts one of Modigliani’s most celebrated contributions, the life-cycle hypothesis. But half a century of empirical evidence has shown that in the US (and other advanced countries) household consumption spending tracks wage and salary income “too closely” for any simple version of the life-cycle hypothesis to be correct (Deaton, 1992). 12 Nothing is implied in this discussion about the marginal product of capital. Since capital is given in amount and fixed in form, no change is possible, and its marginal product is not defined. 13 It is tempting to set the model out in the form Y  AN , so that w/  AN 1. Then becomes the parameter governing the rate at which returns diminish. However, the power function is only one of several forms that the relationship between Y and N might take. In particular, the log form will be important. 14 Rymes (1989, pp. 37–38) suggests that the real argument of the “Manifesto” by Robinson and Kahn concerned this effect. Rymes argues: If the increase in investment . . . results in a sufficient increase in demand, not only a higher price but also an increase in the costs of production facing the entrepreneur in the consumption goods sector, such that the new equilibrium, . . . entails a higher outlay on consumption goods, then it is possible the decline in the output of consumption goods could, in terms of effects on the volume of employment, more than offset the increase in the output of capital goods. Investment increases and consumption declines. 15 “Forced saving” was traditionally ascribed to the effects of an exceptional increase in the quantity of money, leading to a bidding up of prices, lowering consumption and

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17 18

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so making an expansion of investment possible. One issue was whether the resulting increase in capital was permanent or temporary; another concerned the effect of the higher prices on rentiers. How the money supply was increased also became an issue, as did the relationship to interest rates. See Malthus (1811), Ricardo (1810), and Keynes (1940), as well as those cited above. But the process cannot continue for too long, for with I rising and C falling, the ratio of capital goods to consumer goods will be moving further and further from its normal level (Nell, 1998a, pp. 458–459). However, the monetary/credit system may support prices for too long – overshooting – provoking a sharp crash. Linear functions and plausible relations between parameters appear to provide unique positive solutions. The Modigliani–Miller Theorem argues that arbitrage ensures that bonds and equity are perfect substitutes. The proposal here is much less extreme; it just asserts that there will be market pressures to pull the current rate of profit and the rate of interest together, in circumstances where the Central Bank is not pegging. We can study these equations by writing them out with a Cobb–Douglas production function and linear coefficients in the other functions; the procedure for solution is simple. This will show that there is no partitioning of the model. That is, employment is not determined in the labor market. It follows directly from the demand for output, given the output–employment function, as in Kalecki. Hicks, following Keynes, initially modeled effective demand by setting up the IS–LM system together with a labor market and a conventional production function. Later he came to feel that this was a mistake (Hicks, 1980–1981). But if returns are constant and there is no marginal productivity adjustment, the markup must be explained; cf. Rima (2003). On these assumptions, investment determines, and equals, realized profits. When households save a certain percentage out of wages and salaries, the consumption line will swing below the wages line, profits will be reduced. When wealth-owning households (or businesses subsidizing top managers) add to their consumption spending in proportion to the level of activity, this swings the C  I line upwards, increasing profits.

References Andrews, P. W. S. (1949) Manufacturing Business (London: Macmillan). Asimakopulos, A. (1971) “The Determination of Investment in Keynes’s Model,” Canadian Journal of Economics, 4, pp. 383–388. Blanchard, O. and Fisher, S. (1989) Lectures on Macroeconomics (Cambridge, MA: MIT Press). Chick, V. (1983) Macroeconomics after Keynes (Oxford: Philip Alan). Davidson, P. (1994) Post Keynesian Macroeconomic Theory (Cheltenham: Edward Elgar). Davidson, P. and Smolensky, E. (1964) Aggregate Supply and Demand Analysis (New York: Harper & Row). Deaton, A. (1992) Understanding Consumption (Oxford: Oxford University Press). Dunlop, J. (1938) “The Movement of Real and Money Wages,” Economic Journal, 48, pp. 413–434. Hall, R. and Hitch, C. (1938) “Price Theory and Business Behavior,” in P. W. S. Andrews (ed.) Oxford Studies in the Price Mechanism (Oxford: Oxford University Press). Hayek, F. (1933) Monetary Theory and the Trade Cycle (trans. N. Kaldor and H. Croome) (London: Jonathan Cape).

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Hayek, F. A. (1941) The Pure Theory of Capital (London: Routledge and Keegan Paul). Hicks, J. R. (1963) A Theory of Wages, 2nd edn (London: Macmillan). Hicks, J. R. (1980–1981) “IS–LM: An Explanation,” Journal of Post Keynesian Economics, 3, pp. 139–154. Hunter, L. C. (1979) A History Of Industrial Power in the US, Vols I–III (University of Virginia Press). Keynes, J. M. (1930) Treatise on Money (London: Macmillan). Keynes, J. M. (1936) The General Theory of Employment, Interest and Money (London: Macmillan). Keynes, J. M. (1940) How to Pay for the War (London: Macmillan). Keynes, J. M. (1972–79) The Collected Writings of John Maynard Keynes, Vols. I–XXIX (ed. D. Moggridge) (London: Macmillan); cited as CW, followed by volume number. Klein, L. (1947) The Keynesian Revolution (London: Macmillan). Kurz, H. and Salvadori, N. (1995) Theory of Production (Cambridge: Cambridge University Press). Laibman, D. and Nell, E. J. (1977) “Reswitching, Wicksell Effects and Neoclassical Production Function,” American Economic Review, 67, pp. 878–888. Lavoie, M. (1992) Foundations of Post Keynesian Economic Analysis (Aldershot: Edward Elgar). Malthus, T. R. (1811) “Depreciation of Paper Currency,” Edinburgh Review, 17. Modigliani, F. (1944) “Liquidity Preference and the Theory of Interest and Money,” Econometrica, 12, pp. 45–88. Nell, E. J. (1988) Prosperity and Public Spending (London: Unwin–Hyman). Nell, E. J. (1992) Transformational Growth and Effective Demand (New York: New York University Press). Nell, E. J. (1998a) The General Theory of Tranformational Growth (Cambridge: Cambridge University Press). Nell, E. J. (ed.) (1998b) Transformational Growth and the Business Cycle (London: Routledge). Ricardo, D. (1810) “The High Price of Bullion,” in The Works and Correspondence of David Ricardo, Vol. III (ed. P. Sraffa) (Cambridge: Cambridge University Press). Rima, I. (2003) “From Profit Margins to Income Distribution: Joan Robinson’s Odyssey from Marginal Productivity Theory,” Review of Political Economy, 15, pp. 575–586. Robertson, D. (1926) Banking Policy and the Price Level (London: P. S. King). Robinson, J. (1956) The Accumulation of Capital (London: Macmillan). Rymes, T. K. (ed.) (1989) Keynes’s Lectures, 1932–35: Notes of a Representative Student (Ann Arbor: University of Michigan Press). Tarshis, L. (1939) “Changes in Real and Money Wages,” Economic Journal, 49, pp. 150–154. Thornton, H. (1802) An Inquiry into the Nature and Effects of the Paper Credit of Great Britain (London: George Allen & Unwin, 1939).

12 Corporate entrepreneurship Schumpeter’s entrepreneurial function updated Laurence S. Moss

Introduction Corporate entrepreneurship (CE), like so many other things in life, comes packaged in different ways. In this chapter I shall emphasize that large-sized corporations, which are famous for exploiting a few good products by taking advantage of massive scale economies, can also create new businesses centered around novel products and services.1 A growing list of companies such as the 3M Corporation, Dell Computers, the Signal Communications Division of AMP, Amazon.com, and the Sony corporation are praised by management experts for their entrepreneurial abilities (see, for example, Ueyama, 1982; Weber, 1992; Sathe, 2003; Burns, 2005). All too often it is only small businesses that are credited with new product creation and innovation. It is generally agreed that small businesses are a major source of new ideas and commercial discoveries (Jewkes et al., 1969 [1958]; Acs, 1992, p. 4). But there are large-sized hierarchical corporations that are also actively involved in and completely at home with new business creation. According to recent research, “much and even most of innovative activity takes place within large corporations” (Audretsch, 1995, p. 104). I shall make use of a growing business-school literature that takes notice of how the design of organizations and their choice of particular management cultures work together to foster corporate entrepreneurship (CE). The concept of CE is consistent with both the early and later writings of Joseph A. Schumpeter. In many ways, the best of Schumpeter’s teachings have found their home in this contemporary management literature. A methodological note is now in order. Of course corporations do not create, discover, and innovate except through the actions and activities of certain individuals who are associated with or often agents of these same corporations. Still, despite the fact that only individuals engage in human action, there are organizational structures and corporate cultures that catalyze, encourage, and harness the actions of people within these organizations toward product development and innovation. Innovation and creative discovery emerge as regular features of those organizations. It is important for economists to take notice of these genuine social structures and appreciate how they function to align human action toward discovery and innovation (Parsons, 1954 [1950], p. 337).

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I shall proceed as follows. First, it is necessary to review the seminal work of Schumpeter, who already in 1911, defined and clarified what is meant by the “entrepreneurial function.” I shall demonstrate that Schumpeter readily acknowledged the possibility of CE. At the very least it can be said that Schumpeter never ruled out this possibility. In subsequent sections, I review several of the classic tales of business innovation and success. The first has to do with the much-admired achievement of Fred Smith. Smith is “the man” who with vision, incredible determination, and Herculean strength, created and “grew” the Federal Express company, revolutionizing our everyday understanding of package delivery. The Federal Express Company is all about a rags to riches success story of a heroic individual, Fred Smith, who put into place his vision. It is entrepreneurship pure and simple. Next, I take a look at the proverbial creation and marketing of the legendary Sony Walkman brand portable music player. While the business media has generally credited the celebrated business leader Akio Morita with this successful achievement, there is evidence that this innovation was much more a team effort or a product of what Galbraith termed the “technostructure.” It this were an example of Galbraith’s technostructure then it would be a dramatic example of CE made to look like individual heroism in the market. In the final sections I pick up on this “team effort” idea and suggest that the structure or architecture of a large hierarchical organization can play a causal role in aligning incentives and encouraging processes of invention and commercialization. While there is no single fail-safe business rule that can be laid down for all start-up businesses to follow, there are certain features or characteristics of enterprising large companies that can be identified and possibly adopted by other organizations. An appreciation of these features points the way toward an important subfield of entrepreneurial studies that can be termed CE. The CE topic is now a favorite at the leading business schools and especially at my school, Babson College.2

The seminal work of Joseph A. Schumpeter In his remarkable 1911 classic, the famed economist Schumpeter identified “the entrepreneurial function (EF)” (Schumpeter, 1961 [1911], pp. 66–88). The EF consists of reshuffling scarce resources into new, more valuable combinations. He reminded his readers that there was a world of vast qualitative difference between continuing to add rolling stock to the stagecoach industry and installing an entire railroad system instead. In Schumpeter’s (1961 [1911], p. 64n) words: “[A]dd successively as many mail coaches as you please, you will never get a railway thereby.” The invention and commercialization of the rail transportation system was something that proceeded from the creative vision of individuals. It represented a great discontinuity with the past. As Schumpeter explained, the entrepreneur creates value by finding a new combination of resources that turns out to be more valuable than other existing combinations (Schumpeter, 1961 [1911], p. 66). The successful entrepreneur

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must perform two important activities. First, this entrepreneur must facilitate the reshuffling of the resources. The entrepreneur must gain managerial control of the means of production and reshuffle them into new and more valuable combinations. This most basic activity – the activity of getting things done – received pride of place in Schumpeter’s several accounts of the EF. But there is more that must be accomplished as well. The entrepreneur must figure out a business strategy to capture some of the value created for the owners of the business (and these business owners may include the entrepreneur himself). In short, the entrepreneur must secure a portion of the new value created as business profits and capital gains. Finally, he or she must take steps to slow down the inevitable erosion of these profits by competitor businesses. This can be done and quite often is done by erecting certain political and legal barriers preventing the entry of rival firms. Tariffs and quotas are standard examples. Patent protection is another. Schumpeter contrasted his appreciation of the entrepreneurial function with a different notion. The function of management and the professionalization of the manager’s role were frequently discussed in the economic literature of both the late nineteenth and early twentieth centuries (see Knight, 1965 [1921], pp. 22–48). The view offered by the acknowledged giant of British economics, Alfred Marshall, may be considered the typical view of the fledgling profession of economists at the turn of the twentieth century. Marshall suggested that the entrepreneurial function was part and parcel of what was most commonly called “management.” I have discussed Marshall’s views about technological entrepreneurship in another place and emphasized how they differed from Schumpeter’s (Moss, 1982). Schumpeter objected to the inclusion of the entrepreneurial function within the broader category of management control because this obscured the “salient point and the only one which specifically distinguishes entrepreneurial from other activities” (Schumpeter, 1961 [1911], p. 77). A manager establishes and enforces habitual routines because “the mere running of an established business . . . is largely a matter of routine” (Schumpeter, 1961 [1911], p. 91). But those performing the EF change the routines established by the managers and overcome considerable resistance in order to “force” the means of production in new directions (Schumpeter, 1961 [1911], p. 106). As modern accounts make clear, the “force” that the entrepreneurs employ quite often involves duplicity and deception. The exercise of the EF requires that individuals grasp the future differently than the great majority of people in the community. Certain individuals have the capacity to envision the future “in a way which afterwards proves to be true” (Schumpeter, 1961 [1911], p. 85). It is the exercise of a uniquely human capacity that Schumpeter described as “intuition.” It was the application of this intuition to business that constitutes the essential cognitive function of entrepreneurship (see also Schumpeter, 2005 [1932], pp. 113–114). Schumpeter insisted that those who are capable of doing this, that is, grasping a future state of affairs before it comes to be, did not constitute a profession.

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This prescience about an altered future is not “as a rule . . . a lasting condition” (Schumpeter, 1961 [1911], p. 78). It is perfectly possible for some individual to exercise the EF at one point in his life and then never again (Schumpeter, 1961 [1911], p. 77). Furthermore, it is “just as rare for anyone always to remain an entrepreneur throughout the decades of his active life as it is for a businessman never to have a moment in which he is an entrepreneur, to however modest a degree” (Schumpeter, 1961 [1911], p. 78). And so it is the EF that is the object of study and not a sociological category we refer to, such as “the legal profession” or “the military profession.” The EF is a genuine if not uniquely human act and a bit mysterious as well. It is tied up inextricably with intuition and genuine creativity, novelty, and discovery (Schumpeter, 2005 [1932]). After Schumpeter, the tendency has been to think of individuals with alternative visions about the future, leading the scarce resources of a region into new directions, hoping that the future business conditions will allow the owners to pay their way and earn entrepreneurial profits as well. Furthermore, it is the source of a fundamental disequilibrium in a capitalist economy that Schumpeter studied as part of his appreciation of “long-waves” of economic growth and development (Schumpeter, 1939). The EF was an important element in the study and understanding of economic development. It helped explain that elusive rise in living standards that is now, nearly 100 years after Schumpeter, still identified as the hallmark of the market system (Rosenberg and Birdzell, 1986; Easterly, 2002). Since the mental, psychological, and emotional side of human action seems to be related to the exercise of the EF, it is only natural that economic historians would take a biographical approach to the study and appreciation of the EF, although in his later writings and especially in his classic book Capitalism, Socialism and Democracy Schumpeter moved sharply toward recognizing the existence and significance of CE (Schumpeter, 1950 [1942], pp. 132–133). I shall return to the “later” Schumpeter in the final sections of this chapter. In order to illustrate the quintessential Schumpeterian entrepreneur, one more proximate to our own time, let us review the legacy of Frederick W. Smith. A number of hagiographic accounts of Smith’s career and accomplishments exist. Sigafoos’s (1983) account is often told and therefore a short description here will suffice.

The story of FedEx Fred Smith started Federal Express Package Delivery between 1972 and 1974, although the seminal idea for a package delivery service has been traced back to a legendary term paper that Smith wrote while attending Yale University in 1965 (Sigafoos, 1983, p. 31). The youthful Smith was prescient. He imagined an altered future before others could do the same. More important, in subsequent years, he acted on that vision and managed to get new things done. He saw that airports around the world were underutilized after midnight, which implied that the relevant opportunity cost of having a fleet of planes take

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off and land late at night at most airports was small. After his prospective company paid the landing and take-off fees to the airport owners and municipal authorities, he hoped that the sum of these fees would at least be manageable, and less than the revenues his business could raise from providing an overnight package delivery service. Who would pay for such a service? Smith also understood the dynamics of modern electronics systems. The trend was toward modularization and miniaturization of the components of electronic systems. This implied that when machines broke down it was no longer necessary to mobilize armies of technicians and service people and move them to specific locations. The modularized part of the machine could be removed and sent by overnight delivery to a single technician who could test the part and send it or its replacement back (actually, the technician might arrange with another distant firm to have the replacement part sent). This had the important secondary effect of helping a business economize on inventory and working capital costs – costs that a savvy business owner would be willing to pay to avoid. (The high cost of capital costs was especially problematic during the early 1970s when Smith started his business because the nominal interest rate exceeded 10 percent.) Based on these back-of-the-envelope calculations, Smith saw a compelling need for overnight package delivery services and a means of profitably providing that service. As Schumpeter understood so well, the bankers did not share Smith’s vision. The story of Smith’s persistent and eventually profitable efforts to raise the financial capital to put his package delivery service into motion is a soap opera of promises, defaults, and duplicity (Sigafoos, 1983). Smith is our paradigmatic entrepreneur and, had Schumpeter not died at sixty years of age in 1950 and instead lived into his eighties, he might have recognized Smith as the personification of his earliest ideas about individuals carrying out the EF against the stubborn reluctance of those following routine business-management practices. Smith’s story illustrates the explanatory paradigm for many studies of entrepreneurship. It consists of several elements or necessary conditions. First there is a discussion of the early childhood and psychology of the would-be entrepreneur. This discussion is followed by a discussion of the vision or imagined future, and an attempt to place a date on when that vision finally came to be held by the individual entrepreneur. Second, we are offered an account of the machinations, duplicities, deliberations, and drama of obtaining command of the resources in society that are needed to establish and set in motion the envisaged business opportunity. Third, the heroic individual entrepreneur “graduates” to the status of expert manager, always growing his business with relentless energy and taking short breaks to lecture to others about what it takes to be a leader. A final chapter might ruminate on what lifestyles might have been like had this entrepreneur/leader not be able to implement his plans. It is impossible to offer a scientific estimate of the percent of the entrepreneurial literature that is welded to the notion that heroic individuals facilitate pioneering innovations and that the field of entrepreneurship is essentially a field in which hagiographic accounts are offered to admiring students of business. My

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subjective estimate is that nine-tenths of the business histories of famous entrepreneurs fit exactly this mold. It is a literature that pays the deepest respects to a broader methodological rule in historical research, which holds that (1) only individuals act and (2) history consists mostly of accounts of heroic individuals (cf. Hook, 1943). This “hero is history” doctrine may have obscured a deeper understanding of how the EF has manifested itself under modern business conditions. Let us consider the venerable achievement of Sony Corporation’s CEO and leader, Akio Morita. We shall see that assisting Morita in his remarkable efforts to introduce the legendary Walkman technology were teams of workmen who proved invaluable to the successful commercialization of the product. It makes a great difference to our account of the entrepreneurial process when we take notice of the team-based support system on which the pioneering entrepreneur depended.

Akio Morita and the development of the Sony Walkman Can a large hierarchical corporation expect its chief executive to be both a leader and an entrepreneur? The mythology surrounding the invention and commercialization of the Sony Walkman insists that that is exactly what CEO Akio Morita accomplished. Not surprisingly, Morita been referred in the popular press as “Japan’s best-known international businessman”; he has been credited with the inspired invention of the Walkman portable music player, one of the most important inventions and innovations of 1979. Morita entered the electronics industry at the end of World War II (du Gay et al., 1997). He and his partner, Masuru Ibuka, learned of AT&T’s transistorized electronic components and quickly applied for a business license to practice that technology. That license was not immediately forthcoming, and it took several trans-Pacific flights and hours of face-to-face negotiation before AT&T agreed to that license. Morita’s small company, Tokyo Tsushin Kogyu Kabushiki Kasha, later renamed Sony, applied the transistor technology to the radio and eliminated the bulky and hot vacuum tube. Their leaner, tougher, and lighter weight transistorized radio became Sony’s profit horse. Their creative innovation spawned hosts of me-too imitators, and today virtually all radios utilize a variant of the transistor technology and its progeny. The Sony Walkman music player came much later. It was launched in 1979 when Sony was already an established, large-sized corporation. This invention/innovation turned out to be as important and profitable as any of Sony’s earlier ones. Most important, it changed the lifestyle of millions of people around the world, who today sport headphones and immerse themselves in a private world of their own choice. Sony press releases suggest that CEO Morita thought of the Walkman invention all by himself while enduring the boredom of another of those trans-Pacific flights to the United States (Sparke, 1987; cited in du Gay et al., 1997, p. 42). An alternative story, which is really not inconsistent with the first, has Morita

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walking the streets of New York City and in a miraculous flash imagining a individualized tape recorder that plays music through headphones (Chambers, 1994; cited in du Gay et al., 1997, p. 42). What both stories have in common is the Walkman invention/innovation flowing out of the mind of a single heroic entrepreneur who sets about to lead the means of production in novel directions. Since Morita was already the CEO of a huge modern corporation, there was no need for bank borrowing – at least not in the form that Schumpeter (1961 [1911], pp. 233–241) described. Morita drew on the resources generated by his own company (its retained earnings) to innovate and later commercialize the Walkman. As Galbraith explained, retained earnings by large industrial corporations had become a substitute for private individual saving and the new fuel for the innovation process (Galbraith, 1971 [1967], pp. 35–38). Despite the story in the company press release, Morita did not start the Sony corporation by himself. His close business partner Ibuka was an important part of the formation of Sony. Similarly, Morita and Ibuka did not develop the Sony Walkman all by themselves. The robust network and corporate culture resonating within the corporate architecture of Sony must get some of the credit as well. Business writer Shu Ueyama (1982) explained that the Walkman was the result of corporate teamwork and not the result of one heroic individual paddling upstream in a world of skeptics and cost-conscious accountants. CEO Morita did not innovate in a vacuum. He may have had the prescient vision, but the actual creation of the Walkman recorder – the physical artifact itself – was the product of a team effort within a highly flexible and innovative corporation. This is a slam-dunk example of CE, although there is plenty of room here to admit that Morita’s leadership was also crucial for the project’s success. It is clear that Morita was in charge of the overall project, issuing periodic challenges to his managers, setting targets, and following up to see how close the staff were to hitting those targets. Morita famously challenged his team of managers to ride down the proverbial learning curve and reduce the manufacturing costs of the Walkman to unprecedented lows. It was Morita who in 1979 set a modest price point of $130 for this revolutionary product, challenging the other managers at Sony to produce business profits at that price (Ueyama, 1982). His managers succeeded.3 I conclude that while it is correct to credit Morita with the (Schumpeterian) intuition or vision, and the persistence and diligence to push the project along, it is disingenuous to omit the importance of other individuals who worked with Morita to successfully commercialize the Walkman. The Walkman is a clear example of a new business that was created in a well-established, large corporation, and this is entirely consistent with the meaning we attach to CE. These other individuals were not merely applying routine management principles to the problem set before them by the visionary entrepreneur. They were creating, discovering, and solving problems in valuable ways. There is often more to the exercise of the EF than the intuition or vision of a single heroic individual. There is the importance of organizational culture and a great deal more. Galbraith credited the vast army of decentralized talents and expertise held by

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many individuals in the organization that has been channeled toward a specific end or purpose by way of the committee system. He named this the “technostructure” and credited it with new product innovation (Galbraith, 1971 [1967], p. 71; cf. Rima, 1991, pp. 547–548). Galbraith could not have been thinking of this Morita example when he wrote that “the head of the modern corporation cannot order up a new civilian product in response to a major exercise of imagination” (Galbraith, 1971 [1967], p. 314). Morita’s Walkman was still nearly a decade away in the future, but Galbraith’s observation is well taken and enough to make us skeptical of Morita’s publicrelations department at Sony. And there are other examples where “bottom-up” entrepreneurship took place within a committee system of a large corporation in somewhat the same way Galbraith described. Let us take a look as the Post-It Notes product from the 3M Corporation.

3M and the Post-It Notes story The 3M Corporation’s invention/innovation of Post-It Notes product is another staple of business education. The story is told of a Texas boy, Spencer F. Silver, who attended Arizona State University and eventually worked his way to a doctorate in organic chemistry from the University of Colorado in 1966 (Weber, 1992, p. 105). He joined the Adhesives Technology department of 3M Corporation and came up with a “low-tack” adhesive. His invention had at least three product characteristics that, while interesting and novel, did not seem to add up to consumer value. First, his glue did not dry to a sandy substance like most other adhesives. Second, it did not melt or easily catch on fire. Finally, it did not stick very strongly. The entrepreneurial event was that of finding a practical application for this adhesive that would result in business profits. Could these characteristics of a weakly adhesive glue be used to produce something of value to customers? And which consumers? Silver spent some part his professional life at 3M Corporation trying to dream up a practical applications for his adhesive that might have some prospect of producing investor profits. His firm actually encouraged this type of speculative busy work and even had a company rule that allowed division company managers “a great deal of freedom to explore new ideas, bootleg projects, and launch new initiatives without prior company approval” (Sathe, 2003, p. 109). Silver’s division manager permitted him to go from colleague to colleague asking advice and seeking guidance. It was another 3M Corporation employee, Art Fry, who spontaneously grasped how the “value creation” might take place. One Sunday, Fry was singing in his church choir when he noticed the bookmarks in his hymnal flying in all directions as he turned the pages (Weber, 1992, p. 106). By making bookmarks laced with Silver’s adhesive, he solved his Sunday morning bookmark problem. Fry realized the marketable potential of his sticky bookmark and presented his (and Silver’s) proposal to the division manager at 3M.

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The supervisors and senior managers at 3M were at first reluctant to commit resources to developing the product, but they soon noticed that the entire staff at 3M had already become addicted to the post-it bookmarks that Fry had wisely passed around to gather praise and support. In 1977, careful test marketing suggested that the company had a big hit on their hands. Within one year both Fry and Spencer had won the company’s highest awards for research and development, and financial rewards were given out as well. The story of the diffusion of the Post-It Notes and the 3M Corporation is a story of teamwork in a large corporate setting (Leifer et al., 2000). It is a story of bottom-up innovation in a hierarchical management structure that was designed to promote new business creation. Division managers were allowed and encouraged to experiment, and to devote a substantial portion of company resources toward new business development and creation. Employees throughout the organization were sensitized toward innovation and creation. It is the saga of a large-sized corporation that was willing to “kiss a lot of frogs to find a prince” (Business Week, 1984, p. 118). Sathe (2003, p. 23) has dubbed this the “small-is-beautiful philosophy” and explained how it works at 3M Corporation and other companies as well: Corporate executives pursuing the small-is-beautiful philosophy set high performance expectations for the division – both for short-term results and for long-term growth – and give the [division general manager] a great deal of autonomy, with no specific marching order on how to deliver outstanding performance. . . . The [division general managers] must balance short-term and long-term considerations, which leads to a consistent emphasis on new business creation. These corporate executives challenge the thinking of the [general managers] rather than telling [them] what to do. Because the division is viewed as the corporation’s primary center for entrepreneurship, these corporate executives are betting on the [division managers’] business convictions and judgments, rather than on their own judgments and convictions. While there are particular names associated with the Post-It product, the new product creation, and the new business that followed, is as much the result of a corporate structure and a business strategy that delegates new business creation to the various division managers. This business philosophy specifically rejects the routine-bound regimen of other large corporations. With 3M, we most definitely do not have the lonely visionary CEO on top, like Morita directing the minions below to develop a reasonably priced Walkman. Instead, we have a bottom-up style of technological creativity and innovation firmly embedded into the business organization. This corporate arrangement is something that management expert John Kay (1995) has termed “internal architectural design.” In the case of 3M Corporation, such design has yielded remarkable fruit.

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The EF embedded in corporate architecture It is difficult to discuss Amazon.com Inc. without mentioning Jeffrey P. Bezos. He is Amazon’s founder and CEO and the person who is generally credited with performing the EF. He is described almost in Schumpeterian terms as imagining an altered future involving the Internet and pioneering a new business model for that future. On January 26, 2002, the New York Times took notice of the fact that Amazon.com was finally turning a profit after years of losses (Hansell, 2002, p. B2). If all continues according to Bezos’s new business strategy, announced that same day in the New York Times, his company will make even larger profits by discounting books and other products while at the same time streamlining costs at each of its five warehouses (Hansell, 2002, p. B2). Profits will follow from the fact that Amazon has become better at order fulfillment, and this means that Amazon is continually innovating in ways that lower the costs of running the warehouses, communicating with customers, and processing credit-card transactions (Hansell, 2002, p. B2). Bezos decided not to raise book prices, but to discount them and capture business profits by pushing down his operating costs. This is very similar to the cost reduction challenges that Morita issued to his staff at Sony. Assuming Amazon.com succeeds with this business strategy of lowering costs, and by this means does capture a larger share of the value created, who will be the entrepreneur credited with the order-processing innovations that result in profits? Who is responsible for reducing the costs of order-fulfillment functions at Amazon.com? In this case, it may not be anyone or any small group of employees. What may be happening at Amazon.com, as has happened at many other high-performing large corporations, is that the company may have figured out how to build a “sustainable competitive advantage from [its] distinctive capabilities” (Kay, 1995, p. 156). Furthermore, this source of competitive advantage is one that other firms in the industry cannot easily replicate, not even Amazon.com’s major competitors. Why can’t Barnes and Noble, say, simply hire away some warehouse employees from Amazon.com and quiz them to learn about Amazon’s novel order-procurement efficiencies? Business ethics aside, it may be that the competitive advantage that Amazon.com enjoys is embedded in the organizational structure and even culture of the warehouse operation itself. It is not in any particular place and not the brain product of any one individual or even a small number of individuals, but resonates throughout the hierarchical organization as a whole. The employees are inhibited from opportunism and self-dealing by “linking social and business life” in some essential ways (Kay, 1995, p. 72). Unlike a secret formula for processing food or making a proprietary liquor, the knowledge that gives a company like Amazon its distinctive competitive advantages cannot be written down and easily copied. It infuses the corporate culture from a variety of directions and takes a variety of forms. What matters is that this engine of falling costs of processing individual orders is expected to tally up business profits for Amazon.com and challenge its major rivals.

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In this case, the entrepreneurial insights are embedded in what might be called “the architecture” of the entire Amazon.com operation. It is not the genius of Morita or the teamwork of Silver and Fry under the nurturing tolerance of the division manager that is the source of these sustained economic profits. Instead, it is the continuous and unending pressure of all those employee minds at work, each “incentivized” by the strong corporate culture of cost cutting and efficiency that Benzos has both set in motion and inspired. In Kay’s (1995, p. 66) words, an organization with a distinctive architecture . . . often emphasizes its dependence on its people. But this dependence should be interpreted in a particular way. That is, the organization is dependent on its people taken as a whole, because the product of the organization is the product of this collectivity. It is not dependent on any single person; every single person in the organization is readily replaceable but the incremental innovation goes on. It is only in these circumstances that added value can be appropriated for the [investors themselves over a significant amount of time]. There is no one name, or a few names, associated with the myriad discoveries. We are no longer speaking of radical innovations and disruptive technologies but of incremental innovations – and it is the incremental innovations that often turn out to be the most profitable of all (Leifer, 2000, p. 3). What has been set in motion is a beehive-like corporate culture, and that can also be an important source of CE. Suppose we extend the Benzos example and consider institutionalizing the EF within the four walls of a large hierarchical corporation. Can an architectural design accomplish such an amazing feat? The evidence suggests that several outstanding companies have made substantial progress in this regard.

CE and the EF According to Sathe, the 3M Micrographics division has progressed well along the road followed by the 3M Adhesive division sketched out above. Also, the AMP Sigcom division has demonstrated a “consistent emphasis and approach for new business creation over the years because of their management cultures and the actions of their top managers” (Sathe, 2003, p. 37). Other companies, like Xerox Corporation and Monsanto, do not have corporate architectures to encourage and nurture the EF in the same way. When accounting for the methods employed by the most innovative companies, Sathe noticed how they worked with their principal customers to learn about what new products they would be willing to purchase and then pioneered the creation and production of these products. This business strategy (also called “relationship marketing”) carries with it several obvious risks. First, the customer could seize the company’s trade secrets and send them to a competitor firm in an effort to negotiate a better price. Second, upon getting the innovative company to commit resources to a new customized product (or service), the

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customer could then change its mind and renegotiate the price to its obvious benefit, stealing away the profits that were the motivation for the innovation in the first place. This is the familiar “hold-up” problem in the business literature (Williamson, 1985, pp. 52–56). Somehow these innovative companies instilled a corporate culture among their employees that did not dwell on the attendant risks of innovating in full view of their downstream customers. Somehow the process worked, raking in solid business earnings and a genuine new product creation. Unlike the legendary lonely inventor turned business entrepreneur, Sathe points out how little financial incentive is really needed within an ongoing business firm to elicit the spontaneous creative effort that so often results in new and successful business creation (Sathe, 2003, p. 106). One necessary condition is that the people within the organization, especially the division managers, be left free to “start new initiatives without prior corporate approval” (Sathe, 2003, p. 220). Creative, playful and duplicitous managers are not punished and are oftentimes admired for their abilities to nurture a new business idea from cradle to market despite the nitpicking accountants and auditors (Bhide and Stevenson, 1990; Sathe, 2003, p. 220).

Embedding the EF in the architecture And there you have it. Several examples of the EF, each defined and illustrated, starting with the lonely eccentric pioneer (Frederick W. Smith) and ending with an entire corporate structure that encourages innovation. Each variant can be immensely profitable, but only one of them is remarkably sustainable. It is this final type of CE that has the promise of becoming the most profitable of the several that I have discussed. Bezos’s attempts to set his workplace alive with employees committed to efficiencies that promote and inflate investor returns can produce achievements that are quickly reflected in rising stock prices, following in the mold of new business creating companies such as Sony and 3M Corporation. The integration of the EF within the architecture of the large hierarchical corporation promises to be the most sustainable version of all. Consider that Morita eventually did retire from Sony, and that Sony’s global brand continues to soar without him. Without an energetic and brilliant replacement, Sony’s stock might have fallen. But no replacement may have been needed. Something like Galbraith’s technostructure is at work. It is as if the main asset of Sony hadn’t left at all since the principal architecture of the firm remained intact. When the EF is embodied in corporate architecture by the artful direction and design and evolution of a corporate culture that resonate throughout an entire organization, you have a source of entrepreneurial profits that cannot be easily removed from that organization by either the retirement of key personnel or by an aggressive competitor hiring away employees. It is a sustainable form of business innovation that can promise a long run of above-average profits to the investor/owners of that business. This type of new business creation is what we recognize as CE.

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Conclusion The prospect of a sustainable competitive advantage that cannot be easily replicated by other firms and continues to generate business profits quarter after quarter after quarter may have been anticipated by Schumpeter himself. In his celebrated Capitalism, Socialism, and Democracy, Schumpeter (1950 [1942], p. 132) restated his understanding of the EF but less in terms of heroic individuals and more in terms of innovators. According to Schumpeter, the EF consists of “getting things done” in a world resistant to trying new products and reluctant resource owners determined not to allow their property rights to be diminished in value as other resource owners reshuffle what they own and command in novel and more lucrative combinations. Schumpeter reviewed his approach in the language of technological entrepreneurship, which was very much the rhetoric of his day and would continue to be the rhetoric of the post-World War II generation, especially in the published work of Galbraith (1971 [1967]; cf. Rima, 1991, pp. 547–548). According to Schumpeter (1950 [1942], p. 132), the “function of entrepreneurs is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on.” But this individual entrepreneur is losing his or her importance, as “technological progress is increasingly becoming the business of teams of trained specialists who turn out what is required and make it work in predictable ways” (Schumpeter, 1950 [1942], p. 132). The pioneer-inventor-turnedbusiness-leader is rapidly becoming a thing of the past, as it is no longer necessary for individuals to visualize things “in a flash of genius” (Schumpeter, 1950 [1942], p. 132). Schumpeter sensed that “bureau and committee work tends to replace individual action” (Schumpeter, 1950 [1942], p. 133), and discussed the possibility that the pioneering innovator will become a thing of the past. In his words: if capitalist evolution – “progress” – either ceases or becomes completely automatic, the economic basis of the industrial bourgeoisie will be reduced eventually to wages such as are paid for current administrative work . . . Since capitalist enterprise, led by its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous – to break to pieces under the pressure of its own success. (Schumpeter, 1950 [1942], p. 134) Schumpeter forecast that innovation might someday cease to arise from a variety of business structures and instead arise from only one monotonic business structure – the large bureaucratized business corporation. It has not at all been the case that the large hierarchical corporation has (in Schumpeter’s words) “oust[ed] the small or medium-sized firm and ‘expropriates’ its owners but in

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the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class” (Schumpeter, 1950 [1942], p. 134). Galbraith’s claim that “the entrepreneur no longer exists as an individual person in the mature industrial enterprise” may be closer to the truth – at least for large innovative corporations. That extreme situation in which entrepreneurship ceases to exist in any form except in the modern large corporation is not yet part of this twenty-first century either. There are plenty of examples of small and medium-sized businesses behaving in this century as Schumpeter described in his 1911 classic (Schumpeter, 1961 [1911]). It seems that on this conditional forecast, Schumpeter was dead wrong. The EF has not become obsolete. But in recognizing the importance of certain types of large business organizations that might through architecture and organizational culture institutionalize the EF, Schumpeter was right on the mark. He identified the business creation form of corporate organization that is now receiving the attention and recognition it deserves (Galbraith, 1971; Sathe, 2003). The evidence is entirely persuasive that certain remarkable, original, and well-managed corporations have managed to institutionalize the EF within the architecture of their organization and therefore give rise to an interesting phenomenon that we recognize and name as CE. In this chapter I have offered a historical perspective on the context within which CE developed that may be of some use to business historians.

Notes 1 According to Douglas Lober (1998, p. 26; see also Burns, 2005), “Corporate entrepreneurship can be viewed as the development of new ventures within firms or it can be viewed more broadly as the struggle of firms to renew themselves through using new combinations of resources.” In this essay, I emphasize the development of new ventures or product lines within existing firms as the essential meaning of CE. 2 Babson College’s flagship program in Corporate Entrepreneurship is entitled “Entrepreneurial Strategies for Innovation and Growth.” It is subtitled “Infusing Entrepreneurial Thinking into the Corporate Setting” and promises those who take the program that they will learn more about “sustaining the spirit of innovation and renewal while keeping day-to-day operations on track in a variety of economic climates” (from the advertising brochure for the June/October 2004 programs sponsored by Babson College School of Executive Education). Another (earlier) brochure contained an interesting point that is worth quoting and with which I agree entirely: “it’s a captivating myth: visionary entrepreneurs working feverishly in their garage[s] and emerging with the breakthrough innovation of the century. But most brilliant ideas that transform our way of life spring from more everyday settings – corporate R&D departments, typical conference rooms, and yes, cubicles” (see the brochure for the September 25, 2002 program entitled “Beyond the Garage” sponsored by the Babson College School of Executive Education). 3 This example is also an illustration of the teamwork that Ingrid Rima has called “a particularly advantageous feature of Japanese firms.” Rima adds that the [Japanese] tradition of long-term employment encourages firm-specific training and work sharing, while also contributing to a lower ratio of administrative and supervisory employees than is typical in American firms” (Rima, 1993, vol I, p. 12).

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References Acs, Z. (1992) Small business economics: a global perspective, Center for the Study of International Business Practice and Commercial Law, 2, p. 4. Audretsch, D. (1995) Innovation and Industry Evolution (Cambridge, MA: MIT Press). Bhide, A. and Stevenson, H. (1990) Why be honest if honesty doesn’t pay?, Harvard Business Review, September–October, pp. 144–151. Burns, P. (2005) Corporate Entrepreneurship: Building an Entrepreneurial Organization (New York: Palgrave/Macmillan). Business Week (1984) The “blunders” making millions for 3M, July 16, p. 118. du Gay, P., Hall, S., James, L., and Mackay, H. (1997) Doing Cultural Studies: The Story of the Sony Walkman (London: Sage Publications). Easterly, W. (2002) The Elusive Quest for Growth (Cambridge, MA: MIT Press). Galbraith, J. K. 1971 [1967] The New Industrial State (Boston: Houghton Mifflin). Hansell, S. (2002) A profitable Amazon looks to do an encore, New York Times, January 26, p. B2. Hook, S. (1943) The Hero in History (Boston: Beacon Press). Jewkes, J., Sawers, D., and Stillerman, R. (1969) [1958] The Sources of Invention (New York: Norton). Kay, J. (1995) Why Firms Succeed (Oxford: Oxford University Press). Knight, F. H. (1965) [1921] Risk, Uncertainty and Profit (New York: Harper). Leifer, R., McDermott, C. M., Connor, G. C. O., Peters, L. S., and Rice, M. (2000) Radical Innovation: How Mature Companies Outsmart Upstarts (Boston: Harvard Business School Press). Lober, D. (1998) Pollution prevention as corporate entrepreneurship, Journal of Organizational Change Management, 11 (1), pp. 26–37. Moss, L. (1982) Biological theory and technological entrepreneurship in Marshall’s writings, Eastern Economic Journal, 8, pp. 3–13. Parsons, T. (1954) [1950] Psychoanalysis and the social structure, in T. Parsons, Essays in Sociological Theory (New York: Free Press), pp. 336–347. Rima, I. (1991) Development of Economic Analysis, 5th ed. (Boston: Irwin). Rima, I. (ed.) (1993) The Political Economy of Global Restructuring. 2 vols. (Aldershot, UK: Edward Elgar). Rosenberg, N. and Birdzell, L., Jr. (1986) How the West Grew Rich: The Economic Transformation of the Industrial World (New York: Basic Books). Sathe, V. (2003) Corporate Entrepreneurship: Top Managers and New Business Creation (Cambridge: Cambridge University Press). Schumpeter, J. (1939) Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, 2 vols (New York: McGraw Hill). Schumpeter, J. (2005) [1932] Development, Journal of Economic Literature, 43, pp. 108–120. Schumpeter, J. (1961) [1911] Theory of Economic Development (New York: Galaxy Books). Schumpeter, J. (1950) [1942] Capitalism, Socialism, and Democracy (New York: Harper & Bros). Sigafoos, R. (1983) Absolutely Positively Overnight! (Memphis, TN: St. Luke’s Press). Ueyama, S. (1982) The selling of the Walkman, Advertising Age, March 22. Weber, R. (1992) Forks, Phonographs, and Hot Air Balloons: A Field Guide to Inventive Thinking (Oxford: Oxford University Press). Williamson, O. (1985) The Economic Institutions of Capitalism (New York: Free Press).

13 Saving globalization Jay R. Mandle

Introduction Ingrid Rima has been quoted as saying that it was important for economists to figure out how capitalism could be improved. This contribution is written in that spirit. It argues that globalization can, and has, dramatically alleviated poverty in previously poor Asian countries. But, because it has not been accompanied by adequate compensatory policies, it has worsened the distribution of income in the US. Globalization, like technological change generally, requires government policies to ensure that its benefits are equitably shared. Before the US political process can assist the innocent victims of progress, the power of wealth in the electoral process will have to be reduced.

Globalization and poverty reduction Throughout the 1950s and 1960s the world was divided into “three worlds” (Reynolds, 1971). The rich capitalist countries – the United States, and the countries of Western Europe such as France and Germany – were the first world. The communist countries, clustered in the Warsaw Pact and headed by the Soviet Union, constituted the second world. And the countries of Africa, Asia, and Latin America – much poorer than the first and even the second – composed the third world. In this grouping, Latin America’s economies were the most prosperous and Asia’s the least, with Africa falling between them, though closer to Asia than to Latin America (Maddison, 2001, Tables B-21 and B-22). With the colonial empires breaking up during these years, and people in the former colonies and poor countries seeking to raise their abysmally low standards of living, the field of development economics was born. Much of its early theorizing held that participation in global markets was what caused underdevelopment. From this perspective, in order to initiate the development process it was necessary for a poor nation to disengage from the international economy. Domestic firms, it was thought, could not successfully compete in international markets. For growth to occur, local firms would have to produce for the national market, protected from international corporations by the imposition of taxes on imports – protective tariffs (Arndt, 1987, pp. 73–75).

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The resulting policies to promote “import substituting” industrialization did bear some fruit. Growth rates of output per person between 1950 and 1973 exceeded 2 percent per year in each of the three continents of the third world, rates far in excess of what had occurred in the historical past (Maddison, 2001, Table A-31). But even as this acceleration was occurring, something much more dramatic was taking place among a handful of relatively small Asian countries. South Korea, Hong Kong, Singapore and Taiwan – later to be dubbed “The Four Asian Tigers” – adopted an approach fundamentally different than import substitution. They embarked on a policy of export promotion. Reasoning that their own domestic markets were too small to support the levels of output necessary for a modern standard of living, the governments in these countries encouraged firms to sell abroad. Particularly in the cases of Taiwan and South Korea this involved a very active role for their governments; rewards were provided to those firms that achieved explicit export targets. The success of these export-oriented strategies was stunning. During the 1960s and 1970s, per capita economic growth rates for the Four Tigers were in the range of 7 percent per year, at least double the level achieved by countries that followed a strategy of avoiding global market competition. Furthermore, export growth was concentrated in manufacturing, precisely the sector about which it had been thought that poor countries could not compete. Thus the experiences of the Tigers not only demonstrated that successful global market participation by poor countries could occur; they also revealed that very high growth rates were possible in them, more rapid than had been the rule generally in the third world (Maddison, 2001, Table C-3). The experiences of the Tigers alone would have influenced the development strategies of third world countries in the direction of a greater emphasis on exports. But their demonstration effect was greatly enhanced by two sets of changes occurring during the 1980s and 1990s. The first were advances in the technologies associated with information processing and storage, communications, and transportation. With these advances, access to global markets became increasingly feasible from even the most remote of countries. Almost anything could be produced almost anywhere, so long as an adequately trained labor force, port facilities, roads, internet communications, and energy supplies were available. The second advance was the increasingly liberal international trade and investment environment that was negotiated in these years. Under the auspices of the General Agreement on Tariffs and Trade (GATT), tariffs were greatly reduced, particularly in the developed nations. Technological advances and more liberal trade permitted an explosion in growth rates of manufactured exports from poor countries. Trade liberalization, advances in technology, and increased manufactured exports are the phenomena that I refer to as “globalization.” Globalization has been largely an Asian phenomenon. Indonesia, Turkey, China, Thailand, the Philippines, Pakistan, and Bangladesh all saw their manufactured exports grow at annual double-digit rates in the two decades after 1980, and India was not far behind, at 9.5 percent per year (WTO, 2006). Elsewhere among the large poor countries, only Mexico experienced such an export boom.

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With globalization, the growth in the export of manufactured goods typically occurs in what have been called “supply chains.” Product components are manufactured in one location and assembled in another, operations that frequently are carried out by local firms licensed by the corporation that markets the final good. These production chains are supervised by brand name companies, but rely on the investment and managerial capabilities of local firms and businesses, as well as on the employment of a domestic labor force. It is because of the important role played by indigenous businesses that it can be said that an Asian industrial revolution is under way. This Asian industrial revolution has produced a dramatic reduction in poverty in the region, though there is considerable disagreement about the precise magnitude of that decline. When poverty is assessed using survey data, the recorded decline is less than when the number of poor people is estimated using data on the output of the economy in conjunction with estimates of income distribution. If the poverty threshold is set at $2.00 (US) per day), one estimate is that in East Asia, where economic growth was very rapid because of China’s phenomenal growth rate, the poverty rate declined from 78 percent of the population to 16 percent, a staggering accomplishment. The other more conservative estimate is nearly as impressive: with it, the fall in poverty is from about 85 percent to 47 percent. Compared to East Asia, South Asian economic growth was less rapid (primarily because India grew less rapidly than China) and the fall in poverty rate was less dramatic. The more optimistic estimate is that the decline was from 56 percent to 21 percent, while the less positive one suggests that the percentage of people living below the poverty rate fell from 89 percent to 77 percent. Where these measurements agree is more important than their differences – poverty in Asia has, in association with the region’s industrialization, been greatly reduced (Bhalla, 2002, Table 9.4, p. 148; Chen and Ravallion, 2004, Table 3). This decline in poverty means that we are living through an historical turning point of momentous importance. The Asian industrial revolution has been made possible by the policies and technologies associated with globalization. That, in turn, means that for the first time countries composed of people of color have a realistic opportunity to attain standards of living that historically have been available only to Europeans or societies dominated by immigrants from Europe. To be sure, this achievement has not yet extended everywhere in the third world. Economic growth in the Middle East and Latin America has been slow, and in Africa, until very recently, almost nonexistent. As a result, those regions have experienced nothing like the improvement in human well-being that has occurred in Asia. But, the fact remains that what has happened in Asia is well understood and replicable. The conditions that enabled Asia to prosper can be reproduced elsewhere.1 Because this is so, a reasonable forecast for the next twenty years or so is that rapid growth will persist in Asia, while at least in some parts of South America, the Middle East, and Africa growth will accelerate, following the pattern set by countries such as China and India.

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Globalization and the US economy Given this situation it is very disturbing that, in the US, large numbers view the progress that has been achieved in reducing human misery as personally threatening. An important source of the hostility to globalization lies in the reality that, with the new global economy, US workers for the first time are in direct competition with workers in poor nations. When production facilities can be set up virtually anywhere, labor markets are no longer fully defined by national borders. And the fact that prevailing wage rates outside of the US are only a small fraction of those in this country means that firms with the potential to be mobile can pressure workers here to accept reduced income levels. Most economists acknowledge this as a problem. However, they typically respond that globalization has at least two positive consequences for the US and that these gains outweigh the losses. First, the spread of growth to poor countries means that markets are being created where previously they were all but absent. This is obviously important when countries the size of China and India are considered, each of which possesses populations in excess of one billion people. As production and therefore incomes in those countries increase, producers located in the US will be provided with opportunities to market goods and services overseas in very large volumes. If what is sold abroad is of high quality and uses advanced technologies, the jobs created in these export industries will tend to be relatively high paying ones. Second, imports from newly industrializing countries allow higher levels of consumption to occur in the US than would be the case if those countries lacked the capacity to produce manufactured goods. The increased supply that results from the geographic spread of economic development makes goods cheaper and therefore more affordable to Americans who might otherwise be priced out of the market. Similarly, enhanced competition could mean that even as prices are going down, product quality is increasing. In short, the spread of economic development almost certainly means that – looked at from the perspective of the country as a whole – globalization promotes enhanced well-being. The typical affirmation of globalization by economists does concede, however, that the process creates downward pressures on the wages of some workers and job loss for others. It acknowledges that, in the interest of fairness, there is a need for compensatory policies. But such a declaration of need is as far as most analysts go. Not discussed are the political difficulties of legislating programs that offset the inegalitarian consequences of globalization. Implicitly, market integration is given a political priority not granted to the politics of adjustment assistance (e.g., Burtless et al., 1998, pp. 131–32). What makes this neglect particularly damaging to Americans is that two mechanisms of dislocation, not just one, are occurring simultaneously. The spread of economic development is being experienced precisely at the same time that rapid technological change is occurring domestically. Indeed, the very innovations that have facilitated globalization are at the same time transforming production methods in this country. Advances in the processing and distribution of

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information mean that not only do employees in this country have to deal with overseas competitors, but they also face the reality that the kinds of skills employers require are changing. Low-wage workers with limited formal education are doubly threatened. They find themselves in competition with workers in poor countries, even as they find that the skills they possess are increasingly obsolete. The result, according to the Bureau of the Census, is that between 1975 and 2004 the real incomes of college educated individuals increased by 32.0 percent, while real incomes of individuals with a high-school degree grew by only 15.2 percent.2 That, in turn, meant that the US income distribution – already the most unequal of all developed countries – became substantially more unequal. The Luxembourg Income Study reports that not only was the US gini coefficient for after-tax household incomes the highest of all countries considered in both 1979 and 2000, but that the increase in income inequality in the US during these years was second only to the increase that occurred in the United Kingdom.3

Campaign finance and inequality In a proximate sense, the reason that the distribution of income in the United States is more unequal than in other developed countries is that the US system of taxes and income transfers does relatively little to alter its market-determined pattern of compensation. The US gini coefficient for the distribution of income that emerges from factor markets is only about 4 percent higher than the mean for the 11 countries in Table 13.1. In contrast, the US disposable income gini coefficient – the distribution after income transfers and taxes are considered – is 60 percent larger than the average of the others. This discrepancy in these two measures of inequality is due to the low level of social spending in the US. As a percentage of the gross domestic product, US spending on public social programs is about one-third less than comparable spending elsewhere. Simply put, the egalitarian social counterweight to the inequalities generated in factor markets is weaker in the US than in Europe. Social spending really does have an impact. Clearly public policy with regard to taxes, pensions, health insurance, wage insurance, and education can be effective in offsetting income disparities. Thus Christopher Jencks is right when he responds to his own question about why the distribution of income in the US is more unequal than elsewhere: “It’s politics stupid.” As he puts it, the problem is that legislators in the US “have . . . shown a persistent preference for relying on private markets rather than public institutions to make economic decisions” (Jencks, 2005, pp. 134–135). This is just another way of saying that US public policy is not designed to offset inequality. What is striking about the US is not only how little is done in this regard. Just as remarkable is how little attention has been directed to the question of income disparities. As Bill Moyers writes, “astonishing as it seems, scarcely anyone in official Washington seems to be troubled by a gap between rich and poor that is greater than it has been in half a century. . . . Equality and inequality are words

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Table 13.1 Market-determined gini coefficient, disposable income gini coefficient, and net direct public social expenditures as percentage of GDP

United States Canada Australia Finland Norway Netherlands Denmark France Germany United Kingdom Belgium Sweden Mean for all countries excluding the US

Market gini

Disposable income gini

Difference between market gini and disposable income gini

Net direct public social expenditures as % GDP

0.48 0.42 0.45 0.39 0.40 0.42 0.43 0.49 0.49 0.57 0.50 0.47

0.37 0.29 0.31 0.23 0.24 0.25 0.24 0.29 0.26 0.34 0.26 0.22

0.11 0.13 0.14 0.16 0.16 0.17 0.19 0.20 0.23 0.23 0.24 0.25

14.7 18.8 19.1 21.7 22.2 19.5 25.6 28.2 26.8 22.9 23.5 28.0

0.46

0.23

0.19

23.3

Source: Market gini coefficient and gini coefficient after public social spending and taxation, Burtless and Jencks, 2003, p. 76; Net direct public social spending as percentage of GDP, Adema and Ladaique, 2005, Table 6. R2 for the relationship between net direct public social expenditure and the difference between market gini and disposable income gini  0.82496, statistically significant at the 0.05 confidence level.

that have been all but expunged from the political vocabulary” (Moyers, 2005, p. 3; emphasis in original). In the political mainstream, neglect and avoidance have been the characteristic response to the growth in inequality. To the extent that there has been any concern expressed with regard to the distribution problem, globalization has come to be the explanatory scapegoat. Much of the political left opposes globalization, spending its energies addressing issues such as labor standards in foreign countries, over which it can have very little influence at best. The political right, hostile to addressing economic inequities at all, flirts with protectionism as a way to mobilize political support. Neither side grapples seriously with the domestic problems associated with globalization and technological change. Why is that so? What differentiates US politics from the politics that are present in other developed market-based economies? Why has an extensive egalitarian policy agenda designed to adjust to the dislocations associated with technological change and globalization not been adopted in the US? There are many factors involved, but my view is that an important source of bias against compensatory programs lies in how political campaigns are financed in the US.

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Only in the US do national legislators not receive any form of public financial support in running for office.4 Only in the US are candidates entirely dependent upon private donations. In the US, the political careers of would-be office holders are determined by their political acceptability to the very small minority of wealthy individuals who make political contributions. According to the Center for Responsive Politics, less than two-tenths of 1 percent of the US population made 86 percent of all itemized campaign contributions for the 2004 elections.5 In Austria, Germany, France, Sweden, Norway, the Netherlands, Belgium and even Canada, by way of contrast, extensive public support is provided to candidates and/or parties, as well as for media purchases. The status of the US as an outlier with regard to the way its political process is paid for is almost certainly directly related to its outlier status concerning efforts to use the public sector to achieve greater income equality. Politics and political debate do not occur in a cost-free forum where all participants are equal. Seeking office requires resources. Only those with adequate funding can be elected. Television advertising must be purchased, the salaries of campaign staffs have to be paid, polling services contracted, and myriad other costs incurred. The money for all of this must come from somewhere. Quite remarkably, classical political theory has been all but silent on this essential element of the democratic process. There has been next to no theorizing about how efforts to seek political office in a democracy should be paid for. But the fact remains that a vibrant political democracy is costly and someone must foot the bill. At the moment, the electoral process in the US shares many of the characteristics of a market. As in a market, what emerges from the process reflects the preferences of those who pay for the product. This is because buying the product – making a significant campaign contribution – means two different things. On one hand, it means advancing the likelihood of electoral success for the candidate with whom the donor is in political agreement. What is purchased in this case is an enhanced probability that a contributor’s favored legislation will be adopted. On the other hand, a donation provides a campaign contributor with access to the candidate. In that way, the donor is provided with the opportunity to influence the views of a potential office holder. To be sure, this is not all that is involved in the political process. Because politicians depend on votes, not just donations, the segment of the electorate that does not make contributions (the overwhelming majority) is also provided with political services. Candidates do have to pay attention to the ideas and interests of their constituents. However, few observers would deny that major contributors gain enhanced influence compared to non-donors. Those who pay are better able to shape the product than those who remain outside the “market.” There are theorists who defend this kind of inequality in determining the content of politics. Richard Posner, a respected member of the federal judiciary and a prominent legal scholar, thinks that the wealthy should be entitled to buy such authority. He writes, “it is not obvious why people or institutions with the largest stakes in the outcome of an election should be denied the opportunity to

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spend more money on efforts to influence the voters [than others]” (Posner, 2003, p. 240). Posner is silent on the likely consequence of the inequality in influence that would result. But it is not hard to identify what it would be. Since campaign contributors overwhelming are conservative high-income recipients, donor influence stands in opposition to policies that would shift resources from the wealthy to the poor.6 Adopting such a program would come at the donor’s expense. While most of the rest of the society might have a stake in providing support to middle-income and low-income people, exactly the opposite is the case among wealthy political contributors. Providing public funds for political campaigns would serve to reduce – though not entirely eliminate – the power of the wealthy in the political arena. A consequence of that would likely be a greater political willingness to respond to the injuries inflicted by technological change and globalization. In the US, politicians now depend on private funding and that tilts policy formation against egalitarian interventions. But the power of the wealthy and their ability to resist egalitarian interventions can at least be partially offset by public funding of politics.

Summary As a society we need to face the two sides of the advances in technology that we have recently experienced. Computerization and all that has gone with it reduces poverty in underdeveloped countries and raises the income level of rich countries. But it also tends to increase inequality in the latter. In response, we need to create a politics that not only acknowledges that the spread of economic development globally is desirable, but that also recognizes the need for domestic policies to offset the costs borne by individuals who find themselves harmed by the process. But democratizing the economy cannot be done without first democratizing the political process. This means that for a more egalitarian income distribution to be assigned the priority that it deserves in light of the effects of globalization, we will have to first liberate the political process from its addiction to private financing.

Notes 1 For it to do so, of course, it has to be assumed that the World Bank is right when it optimistically argues that “continued and even accelerated economic and human development is sustainable and can be consistent with improving environmental conditions” (World Bank, 1992, p. iii). 2 Economic Report of the President 2006, Table 2–1, p. 50. 3 Luxembourg Income Study, Income Inequality Measures. http://lisproject.org/key/ figures/ineqtable.htm. 4 This paragraph is based on Mandle, 2004, pp. 53–63. 5 Center for Responsive Politics, “Donor Demographics,” http://www.opensecrets.org/ bigpicture/DonorDemographics.asp?Cycle2004&Filter. 6 A study of campaign donors in 1997 found “congressional donors to be mainly wealth, upper-status men, who tended to have conservative views, especially on economic

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issues” (John Green, Paul Herrnson, Lynda Powell and Clyde Wilcox), “Individual Congressional Contributors: Wealthy, Conservative and Reform-Minded,” http://www.opensecrets.org/pubs/ donors/donors/ASP.

References Adema, W. and Ladaique, M. (2005) Net Social Expenditures 2005 Edition: More Comprehensive Measures of Social Support (Paris: OECD). Arndt, H. W. (1987) Economic Development: The History of an Idea (Chicago and London: University of Chicago Press). Bhalla, S. S. (2002) Imagine There’s No Country: Poverty Inequality, and Growth in the Era of Globalization (Washington, DC: Institute for International Economics). Burtless, G. and Jencks, C. (2003) American inequality and its consequences, in H. Aaron, J. M. Lindsay and P. S. Nivolo (eds), Agenda for the Nation (Washington, DC: Brookings Institution), pp. 61–108. Burtless, G., Lawrence, R., Litan, R., and Shapiro, R. (1998) Globaphobia: Confronting Fears about Open Trade (Washington, DC: Brookings Institution). Chen, S. and Ravallion, M. (2004) How have the world’s poorest fared since the early 1980s?, World Bank Policy Research Working Paper 3341, June. Economic Report of the President 2006 (2006) (Washington, DC: Government Printing Office). Jencks, C. (2005) Why do so many jobs pay so badly?, in J. Lardner and D. A. Smith (eds), Inequality Matters: The Growing Economic Divide and its Poisonous Consequences (New York: New Press), pp. 129–37. Maddison, A. (2001) The World Economy: A Millennial Perspective (Paris: OECD). Mandle, J. (2004) The politics of democracy, Challenge, 47 (1), pp. 53–63. Moyers, B. (2005) The fight of our lives, in J. Lardner and D. A. Smith (eds), Inequality Matters: The Growing Economic Divide and its Poisonous Consequences (New York: New Press), pp. 1–13. Posner, R. (2003) Law, Pragmatism and Democracy (Cambridge, MA: Harvard University Press). Reynolds, L. (1971) The Three Worlds of Economics (New Haven: Yale University Press). World Bank (1992) World Development Report 1992: Development and the Environment (Washington DC: The World Bank). World Trade Organization (2006) Statistical Data Base. http://www.wto.org.

14 Labor markets, economic development, and job quality Ingrid Rima’s contributions to labor economics Daniel Kostzer

Introduction There are some articles or books that radically impact ideas and are influential for decades. They piece together analytical frameworks to build up a completely new argument, almost a new paradigm. These are few and far between, and there may be only a handful of papers, articles, even books that meet this description. Ingrid Rima’s article “Sectoral changes in employment: an eclectic perspective on ‘good’ jobs and ‘poor’ jobs” (all page numbers henceforth refer to Rima, 2000, except where noted) is one of these. It is a rather short article that not only gathers other economists’ ideas on the functioning of labor markets in order to explain wages differentials across sectors, but also provides a completely new approach that integrates different levels: the micro, the mezzo or sectoral, and, of course, being Post Keynesian, the macro. For years, Ingrid Rima has argued that Post Keynesian economics must incorporate the labor market into their analysis, as it has a central function in the economy and deserves a different type of analysis from the mainstream approach. In a nutshell, the labor market is the gear-box or transmission that links the economic structure – the macroeconomic setup – with the well-being of households, their satisfaction of the most basic needs in a dynamic and recursive process. In this short article I will try to show how Ingrid’s innovative approach is helpful in understanding the long debate on the so called informal sector, or other kinds of dual and complex labor markets, as well as in analyzing development strategies in the framework of globalization. This analysis suggests some policy recommendations, always a major focus in Ingrid Rima’s work.

Sectoral wage differentials according to Rima Rima states very clearly that the neoclassical approach (which starts from the assumption that the labor market behaves similar to any other commodity market, where supply refers to individuals that make independent and voluntary

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choices between leisure and work according to the salary or wage offered) fails to capture the complexity and institutional make-up of real world labor markets. According to the orthodox approach, individuals also make choices between investing in their own – or other family members’ – human capital today in order to get higher returns in the future. Individuals sell their labor services, while there is a firm that buys them according to market rules. These approaches tend to ignore that most of the time, especially in countries with lower relative economic development, workers have no choice. The need for survival dominates real-world employment considerations. The neo-classical approach states that the real wage represents the marginal productivity of labor, an assertion with no empirical foundation. The orthodox approaches fail to explain unemployment, wage differentials, or why two individuals with similar qualifications go to the same job interview at two firms and one gets a good job, meaning good salary and benefits, job security, and working conditions, while the other gets a poor job, in the informal sector, with no stability, no benefits, and low pay. Rima’s article puts forward a very illuminating framework that links aggregate supply and aggregate demand in a Keynesian fashion with the characteristics of markets in which different groups of firms perform. Rima’s challenge is to try to integrate the micro and sectoral factors into “. . . the body of macroeconomics whose concern might well be extended to shed light on sectoral employment patterns” (p. 172). None of the previous attempts has been linked to “a macroeconomic employment model that can serve as an analytical framework for relating labor market outcomes to the creation and financing of new production functions that cause different sectors of the economy to develop in different ways and at different speeds over time” (p. 173). These insights also help to explain behaviors under different patterns of growth of a country under a set of alternative policy choices. In short, firms, according to expectations, offer in the market a set of working posts at a salary, while individual workers apply at the “slot” they consider fit, trying to get the one that pays the most. There is little doubt that this aggregate job offer, linked to Keynes’s Z function, depends above all else on aggregate demand and it may vary according to the pattern of growth the economy faces. It is not the same under different strategies, exchange rate or trade regimes. Structural matters, product matters: price-taking and price-making firms Rima makes a very clear cut distinction between two types of firms, depending on the pricing system of their products. The difference in the behavior of pricetaking and price-making firms is crucial when it comes to the way in which they link to the overall economy, and especially to the labor market. Price-taking firms, mainly small ones, experience diminishing productivity at the margin, and obviously, hire workers in the same way as variable inputs at an exogenously established wage rate. Those firms face inelastic price and income

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elasticity, since they are concentrated in basic necessities and other goods and services that operate under Engel’s Law. Since they operate in competitive markets, marginal costs are larger than average costs, implying they have diminishing returns to scale, mainly due to the fact that if there is significant income growth due to an increase in real wages, the expenditures on them became proportionally smaller. To some extent this is similar to what was depicted by Raul Prebisch when analyzing the way in which the economic periphery, producing agricultural and primary goods in the world economy, would face terms of trade deterioration. The price-making firm, on the other hand, grows by increasing its market share. These firms operate in a market selling goods and services with high price and income elasticities, and when wage incomes rise, their sales will increase more than proportionally. There is a fixed mark-up rate on prime costs – that include wages and may or may not include interest on working capital – while fixed capital is mainly financed by retained profits. This implies increasing returns to scale, average costs constantly descending, plus other stylized factors expressed by Kaldor and Kalecki, that depict the way in which these firms operate in different parts of the world. Most of them have excess capacity, as a result of previous over-investing. This is a long-run strategy in order to set barriers to entry to new firms in the upswing of the cycle, reacting rapidly in order to avoid new competitors from home or abroad. Operating under excess capacity, in general, implies diminishing average costs, even if the wage rate rises at the same rate labor productivity, since the contribution of the mark-up to cover capital costs and profits is at a fixed rate. With the changes associated with new patterns of industrial organization, however, the Fordist schema prevails where the productive structure is fixed in the short and medium run. Technological choice implies a set of skills and qualifications that are indivisible, and in general involve all types of workers (e.g., professionals, technicians, operational, non-skilled, and administrative) in fixed quantities. Production is organized in shifts or the inclusion of new lines of production of similar characteristics in terms of production and job offers. This is quite different in the case of services. There is a clear link between job offers and capacity utilization, and this is expressed in labor productivity. The larger the firm’s output, the lower its unit costs of production and higher labor productivity. In this respect, wages in the price-making firm are the result of institutional arrangements, where unions play a key role, and not at all the result of the overall labor market: Even at constant wage rates, increasing employment is associated with a rising wage bill. Thus even proceeds are rising more rapidly than employment, the non wage income share is possible higher than the one going to wage and salary workers, which would predispose the economy toward a higher savings and/or the consumption of high priced services. A change in the distribution of GDP between classes of income receivers is not,

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Summarizing, Ingrid Rima states that the link between aggregate demand and supply, products, income growth, and firm behavior define the characteristics that the labor market will have, the quantity of job offers, and how they will be distributed between good and bad jobs.

Rima’s contribution to understanding dual labor markets and Fordism Following the end of World War II, most less developed countries (LDCs), and especially the more industrialized ones, pursued a strategy of import substitution industrialization (ISI). This strategy involved protecting domestic markets in order to reduce their dependency on imported goods, and the process was reflected in the integration that developed. The integration that operated in three dimensions was initially at the social level. Capitalists and workers reduced class conflict to very specific moments in time, since the growth in aggregate demand induced investment, and jobs. Income increases, and the lack of external competition, meant that goods for the domestic market were produced in the price-setting sector rather than abroad. At this point the state defined some of the basic institutions that regulated labor relations. They also employed counter-cyclical economic policies via expenditures and taxes, to avoid fluctuations. There was also what Rima mentions, citing Eckstein, a “high degree of symbiosis between oligopolistic firms and unions” (p. 183). This integration was also at the sectoral level. The growth of the pricemaking manufacturing sector was integrated with the provision of goods and services from the price-taking sector, and increased the profits of those firms. Depending on the size of the economy there, the Arthur Lewis hypothesis on the elastic supply of labor was a very sensible assumption. At this point the state was in charge of investment in those sectors with slow maturity, or that were not profitable, but were indispensable for the private sector performance. In large territories, the social and sectoral integration was reproduced at the local level, developing price-taking firms in smaller cities and towns, but with a particular dynamic of growth in the medium run. In some regions the state was the largest employer, guaranteeing acceptable levels of domestic demand. In a very schematic manner, this was the way in which most large and medium-sized LDC economies grew during the 1950s and 1960s, until the oil crisis and the implementation of orthodox structural adjustment programs.

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The informal sector and the labor market The informal sector is one of the more frequently used concepts used to define dual labor markets or dual economies.1 The informal sector (which can be a very elusive concept) is a characteristic of different economies, but is primarily relevant for countries of intermediate industrial development. The concept of the informal sector is used in different ways by different people. Some use it to refer to small-scale firms, others to the self-employed, and yet others to cottage industries with simple reproduction of the household, but there is also a large underground economy involving illegal activities that may involve large amounts of money, including hiring immigrant workers in substandard conditions. Sometimes the informal sector refers to non-registered or non declared workers, but there are other explanations for this phenomenon.2 In general it is argued that the informal sector has the role of providing jobs, due to the structural inability of the economy to generate employment in the formal sector. Following Rima’s view, the difference between the formal and the informal sector, where wages differentials can be substantial, has its roots in the characteristics defined in the second section of this chapter. The informal sector can be defined as the price-taking sector, while the pricemaking sector is the modern or formal one. The informal sector tends to produce goods and services that become inferior goods after certain levels of income. Consumers tend to substitute the goods and services provided in the neighborhood for more sophisticated ones from oligopolistic firms. They range from industrial products, clothing, or food, to amusement, education, medical or child care. If profitable, these activities may be appropriated by a large firm with oligopolistic behaviors. On the other hand, and as was seen in the Argentinean crisis of 2001–2002, the reduction in the level of economic activity due to the sharp decline in overall incomes shifted part of the demand from the more formal firms of the pricemaking sector to those that can be considered the informal sector, until the purchasing power of the population started to recover, when demand shifted again to the formal sector, inducing the creation of formal jobs. Under the ISI pattern of growth, with a starting point of a large surplus of workers, the price-making sector of the economy generates jobs, enhancing the purchasing power of the employed and, via their demand, the price-taking sector increases it level of production, also generating new jobs there. Although the economy has two-tier or dual labor markets, in this schema the rate of growth is similar, since one sector pulls the other. Wage differentials may be constant in the long run, but this is not a necessary condition. It may work the other way around. Rima’s differentiation between sectors is an interesting theoretical framework allowing a more precise taxonomy of dual economies and the way in which they perform, surpassing the more sociological and classless characterization of the formal and informal sectors.

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Structural adjustment, globalization, and labor markets In section 4 of her chapter, Rima analyzes the changing environment of consumption and production, and outlines why the technologically progressive manufacturing sector has been deteriorating and downsizing. This process is not unique to the USA or developed economies. Bretton Woods institutions induced pro-market structural adjustment policies pushing for deregulation of domestic markets, opening of financial and goods and services markets, and at the same time increasing new intra-firm arrangements of putting-out and outsourcing that deteriorated the employment performance of the price-making sector. These had a “disarticulating” or disintegrating impact on LDCs. These developments can also be explained within Rima’s theoretical framework. The opening of the economy increases competition with the price-making sector. The oligopolistic structure of the domestic market is now open to foreign firms, which are price-makers even at world level. This effect is enhanced if, on top of the so-called pro-market policies, the exchange rate is used as an anchor to fight against inflation, and appreciation of the domestic currency occurs. When the price-making sector faces international competition due to the deregulation of domestic markets, the expansion in domestic demand generates leakages to imported goods. The reduction of employment in the price-making sector, even if on average real wages in the sector remain constant, reduces aggregate demand from workers – the natural market for the informal sector – in addition to the increased pressure on those jobs from those laid off from pricemaking firms. The price-making sector shrinks, expectations are dimmed, not only due to aggregate demand reduction, but also from the additional aggregate supply from abroad. Labor productivity may improve, but a process of disintegration takes place: social disintegration, since in some sort of “free market,” the only variable that may foster short-run profits are wages; sectoral disintegration since firms face a wider range of suppliers, most of them from abroad; and regional or local disintegration due to the fact that the reduction in employment at the main industries in certain regions reduces aggregate demand at the local level. Pro-market policies, deregulation, and the opening up of the domestic market to foreign oligopolistic firms increases within an institutional framework such as the WTO, with its limitations on subsidies and reduction of degrees of freedom for national policies. Almost overnight there is a transformation of oligopolistic, price-making firms with increasing returns into competitive, price-taking firms exhibiting diminishing returns, facing the competition not only of other companies from abroad, but also large corporations that can behave as oligopolies at the global level. This has a definite impact on labor markets, shifting good jobs into bad jobs. The flexibility of the labor market is seen as the only tool to recover competitiveness. The idea behind this is to expand the level of aggregate demand, increasing foreign-market shares or from higher-income groups inclined to

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consume imported goods. This also stresses labor markets, inducing worker turnover and transforming employment, from head of household core workers toward secondary workers (youngsters or spouses). The less the stability in the labor market, the higher the savings by workers in order to cover possible periods of unemployment, the lower aggregate demand, the lower proceeds of firms, and the less jobs in either sector. Without a doubt, when a firm stops performing in the price-making sector, it has a more limited ability to create good jobs. The enlarging of the competitive sector has implosive effects in the medium run, reversing the pattern in the labor market, suggested by Arthur Lewis.

Exchange rates and employment Professor Rima’s approach also helps to explain the behavior of an economy under different exchange-rate regimes, and provides the micro foundations for evaluating them. The exchange rate can have various effects on the level of employment in a country. An appreciated exchange rate has the effects that were stated in the previous section, since reducing the oligopolistic power of price-making firms has a negative impact on the creation of good jobs, and the results in the informal sector can be ambiguous or equally negative. How does a competitive exchange rate impact employment and what are the micro-foundations of these impacts? According to Frenkel and Taylor (2006) there are three channels by which a competitive exchange rate impacts on the level of employment. The first one is the macroeconomic channel, where the devaluation can, using fiscal policies, offset the recessionary effects that they have in general (Krugman and Taylor, 1978). The point is to know how the economy will react to the new set of relative prices and to what extent the production of tradables covers the other effects. If expenditure shifting prevails over expenditure switching, the devaluation can have positive effects on employment. As was pointed out, since large income effects occur under massive devaluations, with transfers from wage earners to non-wage earners, counter-measures have to be implemented in order to ease recession. Argentina’s devaluation is a clear case of this. A few months after the devaluation the government put in place a massive employment program transferring almost 1 percent of the GDP to the unemployed in order to reduce the lag in domestic demand. At the same time, wage increases were implemented for the private sector. It is true that economic theory was not behind these measures, rather the need for social compensations to a vast sector of the economy that was facing poverty and hunger. At that point even democratic institutions were on the verge of vanishing. The new exchange rate becomes a de facto protection of domestic markets. With massive unemployment and significant excess capacity, plus low inventories after four years of recession previous to the crisis, the devaluation sets again

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as price-making firms those from sectors that suffered the competition of large imports during the 1990s. As Rima’s model points out, under those initial conditions, employment recovers faster and more sharply in those goods that otherwise were imported, generating the multiplying and accelerating effects that allow them to generate a process of real wage increases, even with underlying high rates of unemployment. The second channel is the so-called development channel, similar to an industrial policy of tariffs and subsidies, that promotes exportables and import substitution. In the case of export promotion, there are not many things to say, but when import substitution takes place, the price-making sector grows at a significant rate, as was stated previously. Many firms try to take advantage of the new real exchange rate, substituting imports for similar domestic goods thereby segmenting the domestic and the international markets, but using (at least initially) production for the domestic market as the source of profits and the platform to jump into the world market. This enhances the oligopolistic position of firms, reduces foreign competition, and exacerbates price-making behavior. In this respect the devaluation, although it implies drastic changes domestically (moreover “exporting” the unemployment to trade partners), is something that can be implemented overnight, without introducing distortions to other markets. In the medium run it can constitute a comprehensive development tool. Of course it only lasts until other countries perform their own devaluation. The third channel is the “labor intensity” one. A competitive exchange rate reduces the use of capital-intensive (and promotes use of labor-intensive) technologies. This increases the employment-to-GDP elasticity, generating more jobs than with the other type of technologies, mainly from abroad. Since this depends on large amounts of fixed capital, it will benefit workers. The more employment generated, the smaller the leakages to imported goods, which will consolidate the process of growth induced by the other channels. In this respect, with the three channels in motion (and this does not imply that they all will work in every country in every situation), the relationship between proceeds and employment shifts from poor jobs in the competitive sector to the offering of good jobs in the price-making sector. This reverses the process in Figure 7 of Rima’s article, increasing employment and increasing capacity utilization in the production of goods. If a reasonable credit system is in place, and credit is allocated to those with lower incomes, or there is a financing of new jobs in firms, the pace of the growth of employment can achieve some mediumrun objectives.

Conclusions Professor Rima’s contribution to the Post Keynesian framework has yet to be fully recognized. She explains how labor markets work in the macro context, where the Z curve becomes a job offer curve, explaining firm behavior according the product markets they face. The conclusion that wage differentials are not attributable to some sociological or cultural characteristics of individuals has

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been challenged by others, but none as consistent as Ingrid’s argument that “they derive from the opportunities for firms in different sectors to benefit from technological changes and positive consumer responses to new products” (p. 188). Her approach contributes to the analysis of dual labor markets, the informal sector in whatever fashion defined, and, most importantly, to the definition of development strategies consistent with achieving high levels of employment. This is one of those articles that promotes a shift in the understanding of the overall economy that cannot and should not be ignored by economists and policymakers.

Notes 1 A dual labor market does not necessarily imply a dual economy. On the other hand, the existence of dual economies may generate dual labor markets. 2 Tax evasion is often what induces formal firms to hire workers and not declare them for social security. Some institutional factors, not directly linked to labor costs, can also be the explanation of this behavior by firms.

References Frenkel, R. and Taylor, L. (2006) Real exchange rate, monetary policy and employment, DESA Working Paper No. 19 (New York: United Nations). Krugman, P. and Taylor, L. (1978) Contractionary effects of devaluation, Journal of International Economics, 8, pp. 445–456. Rima, I. (2000) Sectoral changes in employment: an eclectic perspective on “good” jobs and “poor” jobs, Review of Political Economy, 12 (2), pp. 171–190.

Index

Publications are indicated by italic type in the heading. Tables and figures are indicated by bold page numbers. Accumulation of Capital (J. Robinson) 48 activism, governmental: J.K. Galbraith on 151–2 aggregate demand and supply: analysis of 125–6; effective demand theory 109–13; “general theory of” 119–25; interaction of 193n1; interest rates 126; models of 7; “textbook” AD/AS construct 113–19 Amazon.com 206–7 America see United States American Capitalism (J.K. Galbraith) 155 American Institutionalism, focus on nominalist facts 164–5 architecture, corporate, and the entrepreneurial function 206–7, 208 Asia, reduction in poverty 214 Asian industrial revolution 214 Asian Tigers, export promotion policy of 213 Babson College 210n2 Babylonian approach 91, 99–100 banks in eighteenth century France 19 Barro, R.J. 114 benevolent dictator model 57 Berlin, Isaiah 34 Bezos, Jeffrey P. 206 Bhaduri, A. 114 Blitch, C. 26 Bober, Stanley 6 Brentano, Lujo 172 Bretton Woods agreement, end of 64, 103, 226 Buchanan, J. 98 Cambridge tradition: criticism of full cost

pricing 80–2; and profit maximization 70–1 Cantillon, R. 20 Capital (K. Marx) 39, 41 capitalism: contradictions in 63; early, price mechanisms in 193n5; economic development as distinct from 173; imperfections in 57; reliant on risktaking 166–7; religion’s role in the development of 171–2; victims of 169–70 Capitalism, Socialism and Democracy (J. Schumpeter) 200, 209 Central American Free Trade Agreement (CAFTA) 50–1 Chick, V. 109, 113, 193n1 Classical Dichotomy 186–7, 191 collective bargaining 164–5 Commons, John Rogers 164 corporate entrepreneurship: Amazon.com 206–7; bottom-up innovation 204–5; and the entrepreneurial function 207–8; innovation in cooperation with customers 207–8; 3M and Post-It Notes 204–5; organizational structures 197; programs at Babson College 210n2; Sony Walkman 202–4 Craft Economy: adjustment in 182; adjustment to demand fluctuations in 182, 183–8; employment inflexibility in 182; and the labor market 180–1; and the price mechanism 182–3; price mechanism replaced by multiplier 188 Crotty, J. 57 cumulative causation 64–5

Index 231 Davidson, P. 16, 96, 97, 193n1 demand fluctuations, adjustment to: in Craft Economy 182, 183–8; in Mass Production Economy 188–92, 190 democracy and the growth of government 149–51 depression in the 1930s 187 development economics 212–13 Development of Economic Thought (I. Rima) 4 Dow, Sheila 99, 100 economic development, capitalism as distinct from 173 economic growth and decline, F. Quesnay on 20–1 economics, interdependence of with political power 152–3 Economics and the Public Purpose (J.K. Galbraith) 154 Economics of the Short Period (R. Kahn) 73 effective demand, theory of: criticisms of 110–12; reconstruction of 109, 109–10, 111; and savings and investment 21–4 El Salvador 50–1 employment: adjustment to demand fluctuations 183–7; and exchange rates 227–8; full, effects of 65–6; inflexibility in Craft Economy 182; in Japanese firms 210n3; and Marshallian technology 180–1; in Mass Production Economy 188–92; and wages 178–80 endogenous nature of money 18–21 Engels, Friedrich 35 entrepreneur: behaviour of and the marginal rule 72–3; capacity for nonworry 166–7; decision process of 72; irrational nature of decision process 77–8; as maximising agent 71–2; and profit maximization 73–5 entrepreneurial function: and corporate entrepreneurship 207–8; development of concept 198–200; embedded in corporate architecture 206–7; FedEx as example 200–1; institutionalization of 9, 209–10 ergodic system, definition of 96 Evolution of Modern Capitalism, The (J.A. Hobson) 168–9 exchange rates: and employment 227–8; wolf pack analogy 65 export promotion 213

Federal Express Company 198, 200–1 Fichte, J.G. 38 forced saving 195n15 Frenkel, R. 227 Friedman, M. 16, 65 Fry, Art 204–5 full cost principle 80–2 Galbraith, J.K. 8, 98; as an institutionalist 158; and attitudes to government 154; centrality of power, belief in 156–8; democracy and the growth of government 149–51; government and corporations 154–5; on governmental activism 151–2; and house ownership 153; institutions, influence on economy 148; interdependence of economics and political power 152–3; and Keynesian economics 158; as a modern liberal in America 153–6; multiple systems of social control and valuation 148–9; political economy of 148–53, 159–60; technostructure 203–4 General Theory of Employment, Interest and Money (J.M. Keynes) 24, 61–2, 76–7 globalization: benefits of 10; effect on the labor market 226–7; growth in export of manufactured goods 213–14; and Marxian economics 49–51; as modern face of imperialism 49–51; and poverty reduction 212–14; and the US economy 215–16 Godley, Wynne 57 government: activism of, J.K. Galbraith on 151–2; growth of, and democracy 149–51 growth and decline, economic: F. Quesnay on 20–1 growth laws 28–9 growth theory: causes of growth 25–9; Post-Keynesian view 24–5; views of F. Quesnay 25 Hahn, Frank 57 Hall, R.L. 80 Hammond, J.L. and B. 169–70 Harcourt, Geoff 6 Hegel, G.W.F. 38, 39–41 Heilbroner, Robert 38 Hicks, J.R. 132, 133, 141, 193n2 historical time 29–30 history, materialist interpretation of 33 Hitch, C.J. 80

232

Index

Hobson, J.A. 168–9, 174n6, 174n7, 174n8, 174n9 Holt, R.P.F. 7, 101 Hong Kong, export promotion policy of 213 house ownership 153 Hume, D. 20 Ibuka, Masuru 202 imperfect competition 73 Imperfect Competition and the Marginal Principle (R. Kahn) 73 imperfections in capitalism 57 imperialism, globalization as modern face of 49–51 import substitution 212–13 income distribution and inequalities in United States 216–17, 217 Industry and Trade (A. Marshall) 71–2 inflation and money 16–17 informal sector of the labor market 225 innovation and organizational structure 197, 205, 206–7 institutionalism, American 8–9 institutions: influence on economy 148; role of and neoclassical economics 98–9; role of in post Keynesian economics 97–9 interdependence of economics and political power 152–3 interest rates: aggregate demand and supply 126; Keynes theory of 129, 140–1; in Mass Production Economy 191–2, 192; and speculation 133–4 Interim Summary of Results (M. Kalecki) 79 investments: in Mass Production Economy 190–1; and savings, causality between 21–4 Jencks, C. 216 Jews and the development of capitalism 171–2 John Kenneth Galbraith: His Life, His Politics, His Economics (R. Parker) 147 Journal through Economic Time, A (J.K. Galbraith) 98 Kahn, Richard 6, 73–5, 79–80, 80–2, 140, 188 Kaldor, N. 7–8, 16–17, 24, 112–13; definition of money 142; growth laws 26–7, 28–9; interest rates 133–4, 141; Keynesian analysis and modern

financial markets 140; marginal risk premium 137; money as rule of account 136–9; speculation theory and Keynes 130–6 Kalecki, M. 6, 65–6, 78–80, 81 Keynes, J.M. 24; cumulative causation 64–5; definition of money 142; endogenous nature of money 19; essence of 58–61; interest rate, theory of 140–1; and modern financial markets 140; post General Theory developments 61–3; price adjustment 192–3; and profit-maximization 76–8; role of money as unit of account 136–9; and savings 22; and volume of employment 188 Kregel, Jan 62, 91 Kuznets, S. 173 labor market: adjustment to demand fluctuations 183–7; effect on of globalization 226–7; François Quesnay on 18; informal sector 225; marginalist account of 178–80; and Marshallian technology 180–1; in Mass Production Economy 188–92; neoclassical approach 221–2; in Post Keynesian economics 221 Lampen, Dorothy 3 Lavoie, M. 94 least developed countries (LDCs) 224 Lenin, V. 49 liquidity preference, theory of 130–6 Lober, D. 210n1 Logic (G.W.F. Hegel) 38 Lucas, R. 96 Machlup, F.A. 75 maldistribution of wealth 168–9 Malthus, T.R. 22 management, entrepreneurial function as part of 199 Mandle, J. 10 manufacturing sector, deterioration of 226–7 Marcuzzo, M.C. 6 Marginal Analysis and Empirical Research (F.A. Machlup) 75 marginal risk premium 137 marginalism and the labor market 178–80 markets: changing organization of 165–6; right of access to 167; and social responsibility 167–8 Marshall, Alfred 4, 6, 71–3, 199

Index 233 Marshallian technology: adjustment in 182; adjustment to demand fluctuations in 183–7; behaviour of profits 184; inflexible employment in 182; and Keynesian wages 180–1; and the price mechanism 182–3; price mechanism replaced by multiplier 188 Marx, Karl 6, 56–7, 62–3 Marxian economics: direct price relationship 45, 45–7; and globalization 49–51; and neoclassical marginalism 47–9; philosophy behind 33–41; relevance to world today 51–4; reproduction model 42–5, 43, 45; value concept 41–2, 46 Mass Production Economy: adjustment to demand fluctuations 188–92, 190; constant costs post-war 194n7 Meek, R. 29 Minsky, Hyman 62–3 Modigliani, F. 193n2, 194n11 Modigliani–Miller Theorem 186, 195n18 monetarism 63 money: endogenous nature of 18–21; exogenous supplies of 19; and inflation 16–17; real world effects of 16–18; role as unit of account 136–9, 142; speculative demand for as obsolete 140 Mongiovi, G. 21 Morita, Akio 202–4 Moss, L. 9 Moyers, Bill 216–17 multiple systems of social control and valuation 148–9 Myrdal, G. 24 natural laws: and Marxian economics 34 Nell, E.J. 9, 97 neoclassical economics: compared to post Keynesian economics 92–3; definition of 92; and role of institutions 98–9; unemployment 1–2 New Deal programs 155 New Industrial Estate, The (J.K. Galbraith) 98, 154 New Keynesian and classical economics compared 58 open-system approach 99–100 organization of markets, changing 165–6 organizational structure, effect on innovation 197, 205, 206–7 Parker, Richard 147, 149, 153, 154, 156

Patinkin, D. 110–12 perfect competition 73 Perlman, M. 8–9 Perlman, S. 164, 166–7 Petty, William 3 philosophy of Marxian economics: materialist interpretation of history 33; and natural laws 34 Physiocrats 29 Physiology of Industry, The (J.A. Hobson) 168 political campaigns, finance for in US 217–19 political economy of J.K. Galbraith 148–53, 159–60 political power, interdependence of with economics 152–3 population mechanism 27 Posner, Richard 218–19 Post-It Notes and 3M 204–5 post Keynesian economics: background to 89–91; and globalization issues 102–5; historical time 93–5; methodology 99–101; need for empirical work 101; real world focus 92–3; and the role of institutions 97–9; savings and investments 101; uncertainty of the future 95–7, 100 poverty reduction and globalization 212–14 power, centrality of 156–8 Prasch, R. 102 Pressman, S. 23, 27, 67n6, 101 price: adjustment 193n3; mechanisms in early capitalism 193n5; movements 193n3; theory of in Marxian economics 45–7 price-taking and -making firms 222–3 Principles of Economics (A. Marshall) 71–2 productivity mechanism 27 profit-maximization: and behaviour of entrepreneurs 73–5; Cambridge tradition 70–1; definition 83n2; and Keynes 76–7; stance against by Kalecki 78–80 Protestants and the development of capitalism 171–2 Quesnay, François 3, 5; on economic growth and decline 20–1, 25, 27–9; and the endogenous nature of money 18–21; and the labour market 18; as precursor of post-Keynesian economics 15; on real world significance of money 17–18;

234

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Quesnay, François continued on relationship between savings and investment 22–4; and the theory of effective demand 23–4 Quintessence of Capitalism, The (W. Sombart) 172 Ramsey, Frank 56–7 rational expectations hypothesis 58 relationship marketing 207 religion and the development of capitalism 171–2 representative agent models 56–7 reproduction model of Marxian economics 42–5, 43, 45 Rima, Ingrid: background 1; career as economist 3–5; and Eastern Economic Journal 3; education 2–3; exchange rates and employment 227–8; and the global economy 5; globalization and labor markets 226–7; informal sector of the labor market 225; interest in history of economic thought 4, 8; neoclassical approach to the labor market 221–2; price-taking and -making firms 222–4; scholarly work of 4–5; and teamwork in Japanese firms 210n3; and unemployment 1–2 Rise of Modern Industry, The (J.L. and B. Hammond) 169–70 risk-taking and capitalism 166–7 Roberts, Hazel 3 Robinson, Joan 4, 6, 24, 47, 48, 78, 140–1, 188 Roman Catholics and the development of capitalism 171 Roncaglia, A. 77 Russell, E.A. 66 Rymes, T.K. 188, 194n14 salaries see wages Salter, W.E.G. 66 Samuels, W.J. 8 Sanfilippo, E. 6 Sardoni, Claudio 7–8 Sathe, V. 205, 207–8 savings and investment: causality between 21–4; Keynes on 22; post Keynesian economics 101 Sawyer, Malcolm 98 Say’s Law 21–2, 102–3 Schelling, F.W.J. von 38 Schumpeter, J. 9, 173, 197, 198–200, 209–10

Setterfield, M. 25 Shackle, George 159 Shapiro, N. 57 Silver, Spencer F. 204–5 Singapore, export promotion policy of 213 Smith, Adam 21–2, 26 Smith, Frederick W. 200–1 Smithin, John 7, 104 social control and valuation, multiple systems of 148–9 social responsibility 167–8 social victimization 169–70 Solow’s growth model 89 Sombart, Werner 172, 175n18, 175n19 Sony Walkman as product of corporate entrepreneurship 198, 202–4 South Korea, export promotion policy of 213 speculation: effect on prices of assets 132–3; elasticity of expectations 132–3; interest rates 133–6; markets for securities 133–6; theory of 131–3 Sraffa, P. 37, 48 Tableau Économique (F. Quesnay) 17–18, 20–1, 23, 25 Taiwan, export promotion policy of 213 Tarshis, L. 57 Taylor, L. 227 technostructure 203–4 Theory of Economic Dynamics (M. Kalecki) 79 Thirlwall, A. 26 3M: corporate culture 207; and development of Post-It Notes 204–5 time, historical 29–30 Toynbee, Arnold 169–70, 175n13 Ueyama, Shu 203 uncertainty, reducing 57–8 unemployment: effect on economic growth 63–4; see also employment United States: attitude to rest of the world 155–6; and effects of globalization 215–6; finance for political campaigns 217–19; income distribution in 216–17, 217; income inequalities in 216; inequality in 216–17; New Deal programs 155 valuation, multiple systems of social control and 148–9 Verdoon’s Law 26 victimization, social 169–70

Index 235 Vilar, P. 19 Vines, David 61 wages: and adjustment to demand fluctuations 183–7; and consumer spending 194n10; and employment 178–80; and Marshallian technology 180–1; in Mass Production Economy 188–92; movements 193n3 Wagner, R.E. 98

Walters, B. 101 wealth, maldistribution of 168–9 Wealth of Nations, The (A. Smith) 21–2, 26 Weber, Max 171–2 Weintraub, Sidney 3 Wisconsin Institutionalism, focus on nominalist facts 164–5 Young, Allin 26 Young, D. 101