Category: Economic Thought

Piero Sraffa: An Introduction

In the first half of 20th century, Marshallian economics dominated economic theory and policy. Keynes in his 1936 book (The General Theory) tries to break away from the orthodoxy by challenging its concepts such as full employment and equality of savings and investment. In 1960, Sraffa mounted a strong critique through his book Production of Commodities by Means of Commodities.

Concepts such as utility, capital, prices, marginal product, marginal cost, etc were questioned by Sraffa. In fact, not only were they challenged, but they were also shown to be problematic. The following paragraphs will show how Sraffa pointed out the inadequacies with the above mentioned neoclassical conceptions of the economy.

Traditional theory lists land, labour and capital as ‘factors of production’. This means that production is carried out using some combination of the above factors. However, the process of production is seen as a one-way avenue from factors of production to production of final goods for consumption. Sraffa, in the tradition of classical economists argued that production is a circular process, or to use Myrdal’s phrase- production is a circular and cumulative process. This was in the tradition of the Classical economists who visualised the economy as an interdependent entity- Francois Quesnay was the first to provide a systematic account of interdependence in his Tableau Economique.

As we know, neoclassical theory of equilibrium prices (value) is built on the twin pillars of production and consumption. It is the production side that provides the supply function; and the consumption side provides the demand function. Through the interaction of demand and supply, equilibrium prices or value is created. This seems plausible and true, at the very outset. Why’ When we think of the production of, say, a car, we presume that both the buyer and the seller has some role in price fixing. Yes, this would be the case if we viewed production (of cars) as an independent activity. Whereas, in reality, production is a social activity and so is consumption. Marshall’s partial equilibrium analysis sought to understand equilibrium price and quantity formation in isolated firms/industries. Sraffa’s 1960 book provides a framework for understanding values (or in neoclassical terms, equilibrium prices) in an economy where production is a social activity and where the nature of production is circular. Hence the title of his book: production of commodities by means of commodities. This highlights the interdependent production structure, which is the case in today’s economies.

In the preface of his 1960 book, Sraffa points out the obvious problems of the ‘marginal method’. To have marginal cost, one needs to pay attention on change. To illustrate, suppose Hero Cycles produce 100 cycles a day using 10 machines and 10 labourers. And production is carried out in this way. How does one calculate marginal cost’ Do we add a machine and see how much extra output is produced’ Or do we ask one worker to work in Hero Cycles for a day’

The above paragraphs are only meant to introduce a reader to Sraffa. To me, Sraffa’s work has brought about a change in how I visualise the economy. Earlier, the linkages between various macroeconomic variables and their micro counterparts were vague. In the following posts, the above mentioned concepts will be explained in more detail. And, concepts such as increasing/diminishing returns, scarcity and prices, joint production, surplus approach, capital theoretic problems, etc will be tackled in the following posts.

Division of Labour: some comments

Division of labour is generally associated with Adam Smith (1776). The concept of division of labour attains significance because it helps in formulating an endogenous growth model, along with the extent of the market. The idea is that specialization has a positive effect on the extent of the market, which in turn leads to more division of labour.

Apart, from this, in everyday life, we come across division of labour in various shapes and sizes. A very strong example of this is that of outsourcing. Earlier, physicians attended to a patient and they were quite knowledgeable in many aspects of medicine. Now, we have ENT specialists, paediatricians, cardiologists, nephrologists, neurologists, orthopaedicians, etc. This is visible in the IT industry as well. And specialization has not left academic untouched either. Within economics, one finds econometricians, economic historians, experimental economists, macroeconomists and so on.

In the Wealth of Nations, Smith [1776] talks of pin-making to illustrate division of labour:

“One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.” [p. 15]

Today, while going through Sir William Petty’s ‘Another Essay in Political Arithmetick Concerning the Growth of the City of London‘ which was published in 1682, I found division of labour mentioned. Petty illustrates it using the example of watch-making:

‘In the making of a Watch, If one Man shall make the Wheels, another the Spring, another shall Engrave the Dial-plate, and another shall make the Cases, then the Watch will be better and cheaper, than if the whole Work be put upon any one Man.’ [p. 473]

Then, while going through the Campbell and Skinner edited Volume of Wealth of Nations, I noticed that in the first foot note, they refer to Petty as probably being the first modern author to talk about division of labour.

Interesting to know that William Petty, hailed by Marx has the first political economist, had developed notions of division of labour!

Paul Samuelson: The Father of 'Modern Economics' Dies

All those who have studied economics for the past 50 years or so have heard about Samuelson – Foundations of Economic Analysis, Samuelson-Stopler theorem, Factor-price equalisation theorem, revealed preference theory, Bergson-Samuelson social welfare functions, non-substitution theorem, linear programming in economics, etc. The first one is his 1947 book which dominates economics teaching even today, directly or indirectly. Samuelson transformed economics into some sort of science (pseudo-science, as some call it)-social physics. [For more on this, go here]

Robert Lucas on Samuelson:

‘Samuelson was the Julia Child of economics, somehow teaching you the basics and giving you the feeling of becoming an insider in a complex culture all at the same time. I loved the Foundations. Like so many others in my cohort, I internalized its view that if I couldn’t formulate a problem in economic theory mathematically, I didn’t know what I was doing. I came to the position that mathematical analysis is not one of many ways of doing economic theory: It is the only way. Economic theory is mathematical analysis. Everything else is just pictures and talk.’ [Marginal Revolution and here]

SCARY!

In his Foundations, he is supposed to have popularised the views of Keynes. In fact, what he popularised is the neo-classical synthesis (IS-LM curves, which were created by Hicks). Hence, what we learn in most macroeconomics texts is not what Keynes said. Post-Keynesian economics is more closer to what Keynes said.

Despite his ‘ideas of good economics’, one needs to appreciate the works he carried out in different areas in economics – macroeconomics, public finance, international trade, consumer theory, capital theory and general equilibrium, etc.

In his initial editions of the Foundations, one could find a few pages devoted to the 1960 capital theory debates. However, with passage of time, the debate was relegated to footnotes. Now, in mainstream textbooks, capital theory is entirely omitted. In fact, Samuelson admitted the problems neoclassical microeconomics and general equilibrium run into because of their notion of capital. [More here]

I end with two questions.
Is mathematics the only way of studying economics and analysing economies’ [We mostly use calculus and game theory. Should we employ other kinds of mathematics’]

How reliable are textbooks’ It makes learning easy, but probably, a bit too easy.

On Prices/Values

Economics, rather Political Economy attempted at providing a coherent theory of value. Economists such as Adam Smith, David Ricardo, Karl Marx, etc are associated with a ‘theory of value’. Currently, in economics, ‘value’ is not discussed in courses of relevance. However, students are exposed to value theories such as labour commanded, labour embodied and so on.

This post is the second in the series of posts ‘On Prices’. This posts attempts at clarifying concepts such as values, prices and costs of production. Note that all prices which are mentioned in economics textbooks (microeconomics, introductory economics, principles of economics, etc) pertain to relative prices or long-run prices. That is, they do not talk about market prices. The reason for this is because it is assumed/believed that market prices tend to fluctuate or hover around these relative prices. In other words, given a particular technology, these relative prices, in some sense, reflect the interrelationships in the economy. Hence, these natural/normal proces are studied in order to understand the workings of a capitalist economy.

Let me start with what is usually taught in various economics and management institutes across the world and even in higher secondary schools. Prices are determined by the interaction of supply and demand. This implies that an excess dmand leads to a price hike. Let us look at an example: Suppose I go to a toy shop and ask for a Meccano set and immediately, another customer asks for the same set. But, the shop has only one Meccano set. Will the price of the Meccano set increase’ Is such an explanation intuitive or common sensical’ This example talks of an isolated case.

Economics is interested in the formation of a spectrum of prices at the level of the economy. Interestingly, macroeconomics has nothing to offer on price formation. Often, or rather everywhere in the world, economics is taught as microeconomics and macroeconomics. The interdependence and interrelationship present in any economy is inadequately addressed. The closest one comes is probably through the ‘circular flow’ diagram which highlights the role of the firm as well as the households. In this diagram, the complex and strutural interdependence is oversimplified to that of a 2-way interaction between the firm and household via labour market, capital market, etc and the state is shown to play the role of a facilitator. The interrelated production structures goes unnoticed or is seldom mentioned. Why is this important’

How can prices be determined’ (The dominant factor will be mentioned.)

1) Demand & Supply – The prices which are determined in this way are the prices of vegetables and fish, prices of shares in the stock markets, price of real estate, etc. In some sense, these prices can be said to be supply determined. For, these commodities are more often subject to variations in supply than in demand.

2)Costs of Production – An alternative view which is present in the literature is that the prices of commodities are prices according to the prices paid to the means of production as well as adding a certain percentage as profit. According to Kalecki, the percentage depends on the monopoly power of the firm. What if the firm’s final product is an input for another firm’ Will this affect the price of the product’ This aspect is often forgotten in economics.

This forgetfulness is strongly associated to the lack of importance mainstream and even some heterodox economic theories gives to interrelationships in the production structures in an economy. To have a glimpse into this, one needs only to look at an Input-Output table.

If we assume (correctly) that production structures in a capitalist economy are interrelated then we can conceptually distinguish goods/services into – Basics and Non-Basics. [Sraffa 1960] Basic goods are those goods which directly or indirectly enter into the production of every commodity in the economy including its own. An obvious example would be foodgrains because they are needed for labourers and labour is required in all activities. And a tax on a basic good will have cascading effects on the prices of all the goods in the economy.

I shall quote Sraffa to point out the significance of accepting and studying interdependence.

The exchange-ratio (or relative prices) of non-basics is “merely a reflection of what must be paid for means of production, labour and profits in order to produce them – there is no mutual dependence.” [p 8, Sraffa 1960]

“But for a basic product there is another aspect to be considered. Its exchange-ratio depends as much on the use that is made of it ….” [pp 8-9, Sraffa 1960]

It is because of these issues that Sraffa uses values/prices than costs. Also, Sraffa knew that in an economy, “costs of production cannot be measured independently of, and prior to, the determination of the prices of products.” [p 9, Sraffa 1960] To conclude, dan we therefore think that Sraffa’s analysis is similar to the neoclassical analysis of price using demand and supply’

In brackets, Sraffa writes “one might be tempted, but it would be misleading, to say that ‘it depends as much on the Deamnd side as on the Supply side.'” [p 9, Sraffa 1960]

References

1) Kalecki, Michal (1971), Costs and Prices, in Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge University Press, pp. 43-61.
2) Sraffa, Piero (1960), Production of Commodities by Means of Commodities, Cambridge University Press.