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Kunkel on David Harvey and Robert Brenner: Demand, Profits and Employment

Posted by Alex M Thomas on 19th May 2014

The link between demand and profits, and consequently employment, is visible in the works of the classical economists and Marx. In this blog post, we set out the link between these variables by way of assessing the contributions of David Harvey and Robert Brenner, as narrated and presented by Benjamin Kunkel in his 2014 collection of essays, all previously published – Utopia or Bust: A Guide to the Recent Crisis (and not on the basis of Harvey’s and Brenner’s original texts).

Karl Marx has already presented us with the possible reasons for the occurrence of crises in capitalist economies. Kunkel treats these crises as profitability crises (pp. 34-6); they can occur because of (1) profit squeeze, (2) a rising organic composition of capital, and (3) underconsumption. A capitalist crisis causes activity levels to drop and results in wide-spread unemployment. The three factors mentioned above reduce the profits of capitalists, consequently affecting their decision to produce and therefore adversely affecting their decisions to employ workers and purchase capital goods. The first – a profit squeeze, is self-explanatory, but its causes need not be. A rise in real wages, ceteris paribus, leads to a decline in the rate of profit. The organic composition of capital, according to Marx, refers to the ratio between constant capital and variable capital. Constant capital refers to the investment expenditure on plant, machinery, tools and other constant/fixed capital. Variable capital refers to the investment expenditure relating to the workers – wage costs, training costs and the like. When the ratio of constant to variable capital rises, or equivalently, when the organic composition of capital rises, the rate of profit (the ratio between profits and capital advanced) falls. The third cause is underconsumption, by workers. This occurs, by definition, since the value of the real wage is less than the value they add to the commodity. In Marxian terms, this difference measures the surplus-value that the capitalists extract from the workers.

I

Strong bargaining power on the side of the workers can generate a rise in the real wages; although, note that the terms of agreement are usually set in money wages. The rising organic composition of capital is not a law, but a contingent proposition. As for underconsumption, if workers’ wages are just sufficient for their survival, it can result in goods lying unsold and therefore affect capitalist profits. To put it differently, there arises a gap between aggregate supply and aggregate demand. This, according to Harvey, places a ‘limit to capital’.

What can possibly eliminate underconsumption, a facet of capitalism, a consequence of positive capitalist profits and a cause of economic crisis? Harvey points out that it is credit which eliminates this cause, at least, temporarily.

‘Any increase in the flow of credit to housing construction, for example, is of little avail today without a parallel increase in the flow of mortgage finance to facilitate housing purchases. Credit can be used to accelerate production and consumption simultaneously.’

(Harvey; as quoted on p. 32)

But, Kunkel cautions us that even if credit can fund the required aggregate demand, changes in income distribution brought about by the struggle between workers and capitalists will affect the aggregate equilibrium, and will render it unstable.

‘If there exists a theoretical possibility of attaining an ideal proportion, from the standpoint of balanced growth, between the amount of total social income to be reinvested in production and the amount to be spent on consumption, and if at the same time the credit system could serve to maintain this ratio of profits to wages in perpetuity, the antagonistic nature of class society nevertheless prevents such a balance from being struck except occasionally and by accident, to be immediately upset by any advantage gained by labor or, more likely, by capital.’ (p. 37)

It is not entirely clear what mechanisms and processes Kunkel is referring to when he makes the above claim about income distribution rendering the equilibrium unstable. Indeed, if the available credit is not sufficient to counter the depressed wages and high profits, the aggregate equilibrium will be unstable.

Another route through which capitalist crisis can be postponed is via long-term infrastructural projects. ‘Overaccumulated capital, whether originating as income from production or as the bank overdrafts that unleash fictitious values, can put off any immediate crisis of profitability by being drawn off into long-term infrastructural projects, in an operation Harvey calls a “spatio-temporal fix”’ (p. 39). Here again, it is contingent on the extent to which the workers gain from the surplus generated by these projects, both in the short and long-term. For example, the employment guarantee programme in India creates infrastructure as well as provides employment and wage income.

‘So what then are the “limits to capital”’ (p. 41)? ‘Keynesians complain of an insufficiency of aggregate demand, restraining investment. The Marxist will simply add that this bespeaks inadequate wages, in the index of a class struggle going the way of owners rather than workers’ (p. 43). Inadequate wages, as previously indicated, does generate demand deficiency. To that extent, Marx’s and Keynes’s account of capitalist crises are very similar.

Kunkel points out the role of environmental degradation, a consequence of capitalist drive for profits, in capitalist crises. ‘Already three-concentrations of carbon in the atmosphere, loss of nitrogen from the soil, and the overall extinction rate for nonhuman species-have been exceeded. There are impediments to endless capital accumulation that future crisis theories will have to reckon with.’ This can be easily integrated into the theories of output and of growth, as Ricardo’s diminishing returns to land, has been. Environmental depletion poses constraints on the supply side primarily and for economic growth, positive capital accumulation is necessary. Therefore, environmental degradation poses a strong constraint on the supply side of the economy.

II

Robert Brenner made a ‘frontal attack on the idea of wage-induced profit squeeze’ (p. 87). As Kunkel puts it, ‘increased competition exerted relentless downward pressure on profits, resulting in diminished business investment, reduced payrolls, and-with lower R&D expenditure-declining productivity gains from technological advance. The textbook result of this industrial tournament would have been the elimination of less competitive firms. But the picture drawn by The Economics of Global Turbulence is one of “excessive entry and insufficient exit” in manufacturing’ (p. 87). In other words, the profit squeeze was not wage-induced.

Marx’s realization crisis finds a mention in Kunkel’s essay on Brenner too. ‘If would-be purchasers are held back by low wages, then the total mass of commodities cannot be unloaded at the desired price. Capital fails to realize its customary profits, and accumulation towards stagnation’ (p. 91). This is the crucial point. Capital has to realize its customary profits, a magnitude which includes a return on risk and undertaking (a return on enterprise, if you like) and the rate of interest. Capital that is invested in a riskier enterprise is expected to provide higher returns. The search for demand (or markets) is not new. Mercantilism was precisely that. More recently, ‘[i]n Germany and Japan, and then in China, catering to external markets won out over nurturing internal demand’ (p. 94) However, currently, there are signs of a reversal as external demand is falling, and net-exporting countries are reorienting towards domestic demand (p. 95).

But, what is to be done? According to Kunkel, ‘[g]lobal prosperity will come about not through further concessions from labor, or the elimination of industrial overcapacity by widespread bankruptcy, but through the development of societies in which people can afford to consume more of what they produce, and produce more with the entire labor force at work’ (p. 98). Kunkel rightly advocates better wages and the full-employment of labour. For, it is only such a society which can afford its citizens with a dignified and economically comfortable life. As a matter of fact, ‘[m]ore leisure or free time, not less, would be one natural-and desirable-consequence of having more jobs’ (p. 103). A similar call is visible in Robert & Edward Skidelsky’s How Much is Enough? Money and the Good Life published in 2012. We urgently need an economic architecture where goods can flow easily across regions, workers earn good wages, capital earns its customary profits, labour is fully employed and the environment is respected. In working towards this goal, it is necessary to possess an accurate understanding of the link between demand, profits and employment.

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Posted in Economic Crisis, Economics, Employment, Karl Marx, Macroeconomics, Prices, Unemployment, Wages | No Comments »

Prices, Competition and Markets

Posted by Alex M Thomas on 31st March 2014

It has become commonplace in India to point fingers at the central government when prices of essential commodities such as onion or fuel rise. The underlying arguments behind this accusation could be that: (1) the government is expected to maintain price stability and/or (2) the government should socially engineer agricultural markets in a ‘fair’ manner. But, is the pursuit of price stability not the job of the Reserve Bank of India (RBI)? It is true that the RBI cannot do anything to combat inflation when it is caused by a supply-and-demand mismatch in the domestic vegetable market or the international oil market. What the RBI can do is manage inflation expectations, and that is for another post. The present post is motivated by the insightful analyses of Kannan Kasturi on the Indian vegetable market, published in the Economic & Political Weekly and other places. That is, this post takes up the second of the reasons mentioned earlier.

The price mechanism – adjustments made by producers to the selling prices and consumers to the purchasing prices – is expected to allocate the commodities brought to the market amongst the consumers, in accordance with their needs, reflected in their willingness to pay. The prices therefore act as signals for the producers especially. Sellers can adjust quantity in order to affect prices; hoarding commodities is one such strategy. At equilibrium, producers earn a normal rate of profit, which contains a pure rate of return on capital advanced and a return for risk and entrepreneurship. If producers do not make normal profits in time t, they will cut down production in time t+1. During the equilibration process, producers who are unable to earn a normal rate of profit will exit the market. If entry costs are low, new producers will enter the market. Producers who have large financial resources (or access to easy credit) at their disposal are insulated from temporary alterations in demand. Producers who have enough accumulated earnings can shield themselves from such market volatility. In short, a competitive market is one where prices are not distorted (by the producers or by external intervention), no (especially, cultural and social) barriers to enter the market exist and workers are mobile within and across markets.

Of course, the agricultural markets in India are far from competitive. Since more than 50% of Indians derive their income from agriculture, and particularly because of the poverty of the farmers, these markets require government intervention. This is not to say that any form of government intervention will better the situation. Kasturi quite convincingly shows that the fault lies with the supply-side – the agricultural supply chain. This post will not discuss minimum support prices or other input subsidies, such as for electricity, irrigation and fertilizers. Also to be noted is the specific manner in which the agricultural input markets are inter-linked in India, which has been of an exploitative nature. Finally, social and cultural factors (pertaining to caste and gender) are seen to hinder competitiveness in Indian markets, not just in agriculture.

What are the problems with the agricultural supply chain? Kasturi points out the following: (1) Small farmers lack storage facilities in order to gain from the high market prices. (2) The middlemen (those who intermediate between farmers and final consumers), i.e. the wholesale traders and commission agents have the ability to hoard vegetables and consequently they reap the benefits of the high prices they themselves engineer; the Agricultural Produce Marketing Act governs the agricultural markets (mandis) and it is here where all the proceeds from higher prices are absorbed with nothing reaching the farmers. These traders and commission agents are ‘well entrenched in the mandis, having been in the business on average for 20 years’ (3) Agricultural pricing is not at all transparent and the mandi records are of no assistance in this regard.

To sum up, the nature of government intervention has to change, in such a way that is beneficial to farmers. Proper laws are of utmost importance, not just in protecting the interests of the small farmers, but also that of the consumers.  Moreover, intermediaries in any market perform useful functions but laws should be in place which ensures that they do not become monopolistic and exploitative. Agricultural infrastructure such as storage facilities is paramount in this context. A very detailed study of how these supply-chains operate will be of much help in our attempts to combat inflation.

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Posted in Agricultural sector, Development Economics, Economics, Government, India, Inflation, Markets, Prices | No Comments »

(Mis)understanding Inflation

Posted by Alex M Thomas on 30th June 2011

 

The recurrent hikes in fuel prices over the last one year are a cause of concern. For, fuel is a basic commodity and it enters as an input directly or indirectly into the production of all commodities – agriculture, manufacturing and services. About a year back, an “expert” committee headed by Kirit S Parikh recommended a partial deregulation/liberalization of fuel prices. This has eased the financial burden of the government. In addition, economists have posited that deregulation will enable markets to become efficient (subsidies and taxes distort efficiency). In any case, the role of the government has been changing rapidly too – from that of a provider to that of an enabler (to quote our Chief Economic Advisor, Kaushik Basu).

A couple of days back, our esteemed Deputy Chairman of the Planning Commission Montek Singh Ahluwalia told the media that the recent hikes in fuel prices was a strategic move. According to him, the hike in prices of petroleum products would help ease inflation in the long run as it would suck money from the system. This post examines this statement by trying to understand the mechanism of inflation.

INFLATION

Inflation, as we know, refers to a continuous increase in the price level over a period. To make sense of this seemingly simple statement, we must have a clear understanding of the two concepts based on which we understand inflation. It is on the basis of this understanding that policy decisions are made both by the RBI as well as the Central Government to control inflation. The two concepts are:

(1)   Time: the price rise has to be continuous over a certain period.

(2)   Index number: inflation is studied by making use of these special averages

Time

How much time must elapse before we can characterise the price increase in an economy as inflationary? In theory, economists solve this problem of having to fix the time period by introducing the distinction between short-run and long-run. However, this distinction does not solve the problem, but only adds to the complexity. What do we understand by short-run? Does it refer to one week, one month, 6 months or one year? Interestingly, there is no fixed answer to this. The distinction between short-run and long-run shows how creative economists are, although its utility is questionable. Short-run refers to the time during which the variables under consideration do not have adequate time to adjust or settle (at their equilibrium positions). Whereas, long-run refers to a period (point?) when all the adjustments are over and all the variables have settled. How convenient! The long-run will remain a mirage.

Given these unsettled issues, how does our Deputy Chairman of the Planning Commissions confidently maintain that fuel price hikes will ease inflationary pressures? This statement is meaningless because the long-run is a fictitious concept. Such statements indicate the misplaced confidence economists possess as well as the poverty of economic theory.

Index numbers

Price level is what we examine in theory when trying to understand inflation. In applied work, we trace changes in indices such as WPI and CPI (which is a proxy for the general price level in an economy) in computing inflation. The construction of a good index number is a difficult task. Selection of relevant variables, choice of base year, the kind of index number to use – Paasche, Laspeyre or Fisher – are some of the issues which have to be tackled. A detailed discussion of index number will feature as a blog post in the future.

Ahluwalia, one of our economic planners, maintains that fuel price hikes will ease inflation in the long run. The explanation he provides for this occurring is both logically and factually incorrect. He said that fuel price hikes “suck excess money out of the system.” Firstly, this statement is based on a particular view or understanding of inflation, namely the neoclassical one. Inflation is seen by this group as a result of excess money in the economy. In the words of economics textbooks, which do an excellent job at indoctrination, inflation occurs when too much money chases too few goods. It is this factually incorrect view which dominates academia as well as the policy arena. In fact, it is this view which is widely communicated in the media as well. Several economists have questioned this notion but with limited success. For, if inflation is not a monetary phenomenon, how will the central banks survive? In any case, this view is not a correct representation of reality because manufactured products and services are not priced on the basis of demand (unlike agricultural prices which are largely demand-determined). [See Who prices the Products? and On Prices/Values] If the prices increase from non-monetary factors, such as production conditions, expensive labour, from a higher profit margin, corruption or rise in fuel prices, how will removal of money reduce inflation? In fact, how does one arrive at a benchmark for computing ‘excess” money? Fuel price hikes, on the other hand, will threaten the livelihood of both the poor consumers and poor producers.

What does our planner mean when he talks of the “system”? A closed economy? An open one? Will the money not still be circulating in the economy even after the fuel price rise? Without clarifying the above mentioned issues, the statement made by the Deputy Chairman of the Planning Commission holds no ground, however scientific it might sound! Such statements only reinforce the arrogance of economists and the poverty of economics!

 

 

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Posted in Economics, India, Inflation, Macroeconomics, Michal Kalecki, Monetary Economics, Neoclassical Economics, Prices | 1 Comment »

Who prices the products?

Posted by Alex M Thomas on 31st January 2011

Recently, Indians have witnessed an escalation in onion prices followed by a hike in fuel prices. Price rise is a phenomenon which affects all sections of the society in varying degrees. Earlier, through the work of Michal Kalecki, a Russian economist, this blog showed the difference between cost-determined and demand-determined prices. The current post examines how products are priced. Majority of the arguments in this post is taken from the book Smart Pricing, authored by Jagmohan Raju and Z. John Zhang published in 2010.

Textbook economics teaches us that it is demand and supply which determine prices. Are the prices of vegetables, rice, chicken, train travel, milk, bread, toothpaste, parathas, etc determined in a similar way? When price changes are attributed to demand and supply, it means that prices are taking their “normal course”. In other words, price movements arising from demand and supply are considered as normal as the law of gravitation. Economic theory ascribes the term ‘invisible hand’ to denote demand and supply factors which cause prices to alter. However, as repeatedly pointed out in this blog, manufactured goods and producer/consumer services are not priced in the market via bargaining. As Raju and Zhang rightly point out, “Price setting is a tangible process with a tangible outcome – a dollar figure. The process of arriving at that number might not be tidy, but it cannot be so mysterious that it does not involve any human intervention. Someone, somewhere must make a concrete, numerical decision about the price of a product or service” (2010, p 2). Further, they argue that “the market does not set prices. Marketers do. All the prices we observe in the marketplace do not just spring out of an autonomous, impersonal market. The managers’ hands in setting those prices are entirely “visible,” regardless of whether such interventions are acts of expediency or strategy” (Ibid, p 11-12).

According to Raju and Zhang products are usually priced based on three approaches: (1) cost-plus based, (2) competition based and (3) consumer based. An overwhelming majority of U.S. Companies use this approach to set prices. Here, the mark-up is determined by the company’s targeted internal rate of return on investment or by some vaguely defined industry convention. Competition based pricing is the second most popular approach and is considered to be strategic. In this approach, the prices are fixed taking into account the prices of similar products in the market. In the case of consumer based pricing, the company tries to determine how much each consumer is willing to pay and then accordingly fixes a price. All the above mentioned approaches indicate that price fixing is a conscious and deliberate action carried out by the company or individual producer.

In microeconomics textbooks and in the media we find statements which ascribe price rise to demand-supply factors. The group of individuals – the capitalists, the brokers, the intermediaries etc – who cause the prices to rise with their actions are completely absent in this account. The book by Raju and Zhang therefore is a must read for all economists who wish to understand how products are actually priced in today’s consumerist society.

Reference

Raju, Jagmohan and Zhang, John (2010), Smart Pricing: How Google, Priceline, and Leading Businesses Use Pricing Innovation for Profitability, Pearson Education: New Jersey.

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Posted in Economics, Inflation, Markets, Neoclassical Economics, Prices | 2 Comments »