Category: Economic Philosophy

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.

On Causality in Economics

This post tries to unsettle some of the methods used in economics today ‘ Regression analysis and Granger causality. Apart from this objective, the post also tries to understand the meaning (rather, meanings) of causality. Do we economists mistake correlation for causality’ Can we have a single method for capturing causality’

Causation is defined in the following ways:

-the action of causing or producing.

-the relation of cause to effect; causality

-anything that produces an effect; cause [Dictionary.com]

And the definition of Correlation is:

-mutual relation of two or more things, parts, etc. [Dictionary.com]

I once asked a professor who had offered to give a lecture for our Advanced Economic Theory class this: ‘Sir, is it possible to establish causation conclusively” He replied ‘That is simple. There are these tests- Granger test, Sims test, Sargent test, McClave-Hsiao test, Haugh-Pierce test, etc.’ And he wrote the names of these so-called ‘scientific’ tests on our black board.

What we often forget is that, there is no single and simple understanding of causation. There are various kinds of causality like epistemic, conceptual, factual, counterfactual etc. Causality in economics also are of different natures- poverty is causing unemployment, increased demand for oil has resulted in oil price rise, supply constraints are hiking up the price, etc. For instance, conceptually we know that poverty causes unemployment (vicious cycle of poverty) and that increased demand causes a concomitant price rise. In economics, it is important to have an account of both conceptual as well as factual causality.

For causality to be present between two variables A and B, it is necessary for them to be related in some way. This relationship among them can be of a linear nature or a non-linear one. If it is linear in nature, then it is called correlation. [Note that regression analysis (OLS) is based on correlation and is linear in nature.] But, correlation alone does not imply causation. Hence, all those who think that causation and correlation are the same make an inductive leap ‘ from correlation to that of causation.

As R G D Allen writes in his Statistics for Economics: ‘This statistical concept of correlation is quite neutral as regards causation. One of the variables may be ’caused’ by the other, but this can only be known from other than statistical considerations.’ Usually, causal hypotheses are derived from economic theory, because ‘data does not speak on its own’. We need to pass data through theory in order to make sense of it.

However, economic theory (like any other theory) contains a lot of assumptions, mostly unrealistic. What happens to causality then’ Causality, then is dependent on these assumptions. Hence, drawing inferences from such theoretical models for practical purposes should be undertaken with caution.

It is this caution that seems to be missing amongst econometricians. This will be evident after looking into the workings of Granger causality. Granger causality analyses probabilistic causality. However, this per se is not a limitation of the test. For, in social sciences, it is exceedingly difficult to talk about deterministic causes in real-world scenario- especially, in a macroeconomic environment.

Granger causality
If X and Y are probabilistically dependent and X precedes Y, then X causes Y.

And, in actual testing, Y is regressed on X (t) and also on X (t-1). If the latter regression is found to be more significant, then X is said to Granger-cause Y. In actual practice, there are economists who forget the prefix. That is, again, some sort of correlation analysis is carried out between Y and X (t-1). In any case, the concept of causation is a problem-ridden one. And as economists who contribute to policy-making, one ought to be on their toes all the time.

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.

Economics Education: The Indian Context

Economics is viewed in most schools, colleges (Management institutes as well) and universities as a monolithic enterprise. It comprises mainly Microeconomics and Macroeconomics and uses Econometrics and Mathematical Economics as tools to understand the economy. Interestingly, tools like philosophy, history, sociology, anthropology lie forgotten. Or probably they are not viewed as tools anymore. Or they are not scientific enough!

This post deals with the dominant perception of Economics within India and how these perceptions adversely affect the spirit of economics in particular and of scientific inquiry in general.

Courses like History of Economic Thought are extended to include Classical Political Economy, Marxian Economics, etc. They are taught as outdated ideas and not as relevant approaches in understanding the economy. This is visible from the responses of students when works of Adam Smith, David Ricardo, Karl Marx etc are mentioned. I shall discuss Malthus in this post and in the next post, I shall discuss some of the theories of Marx.

Unfortunately, Malthus is known only for his ‘bad’ population theory. Interestingly enough, all that Malthus [1798] said was ‘that population, when unchecked, increased in a geometrical ratio, and subsistence for man in an arithmetical ratio.

Let us examine whether this position be just. I think it will be allowed, that no state has hitherto existed (at least that we have any account of) where the manners were so pure and simple, and the means of subsistence so abundant, that no check whatever has existed to early marriages, among the lower classes, from a fear of not providing well for their families, or among the higher classes, from a fear of lowering their condition in life. Consequently in no state that we have yet known has the power of population been left to exert itself with perfect freedom.‘ (Italics added)

Such an argument is what philosophers of science classify as a ‘thought experiment’. But mainstream economists classify this as a theory which has provided wrong predictions.

Thought experiments are devices of the imagination used to investigate the nature of things. And in our own time, the creation of quantum mechanics and relativity are almost unthinkable without the crucial role played by thought experiments. [Brown 2007] If one were to discredit and disregard Malthus’ theory, then there is no reason why the theory of perfect competition should be considered in Economics at all. The issue is that, there is hardly any work being done in methodological issues pertaining to economics and on the structure of a good economic theory, therefore one definitely needs to consider each and every theory in its own context. By context I refer to the historical background and the general argument that is being put forth.

Philosophical debates within Economics are very essential for the growth of both the disciplines, but more significant for economics. Methodological and epistemological issues are not commonly discussed in economics. This is very necessary because economics, economists and economies are ever growing in importance. Their policies have far reaching effects. And if they are not constructed in the right spirit, the objectives of the policy might not be fulfilled at all. The Indian budget 2008-09 is one such example. None of the Indian universities have a course pertaining to the Philosophy of Economics in its Masters’ courses. This shows the importance it has received vis-a-vis econometrics and game theory.

Also, economics claims to be a science and Professor Peter Englund, Secretary of the Economics (Nobel) Prize Committee thinks so as well when he says ‘In all relevant respects the committee understands and treats economics as a field of science.’ I see it as a shirking away of economics from questioning itself- its methodology and its knowledge.

It is primarily this attainment of a scientific nature by mainstream neoclassical economics that is bringing doom to the people constituting the economy. The present analysis in mainstream economics is not only ahistorical but also asocial. Economics needs to understand its origins and its epistemology. It ought to be a pluralistic enterprise. And let theoretical anarchism prevail because ‘it is more humanitarian and more likely to encourage progress.’ [Feyerabend 1975]