Economics without Equilibrium

Nicholas Kaldor

• Publisher: Routledge
• Year: 2020
• Print ISBN: 9780873323369
• eBook ISBN: 9781000161229
• Topic: Politics & International Relations
• Subtopic: Economic Policy
• Index: Politics & International Relations

This book contains lectures delivered at Yale University in October, 1983, in memory of Arthur M. Okun, showing how Lord Kaldor relates his own views of economic process to those of Okun, particularly the theory of markets set in Okun's magnum opus, Prices and Quantities, posthumously published.

II

Supply and Demand

The main conclusion of the first lecture was very much the same as the main conclusion of Arthur Okun’s posthumous book Prices and Quantities, namely, that in the vast majority of cases (which means in practically all cases except for certain staple products of agriculture and mining) the sellers are price-makers and quantity-takers, and not, as Walrasian equilibrium theory supposes, price-takers and quantity-makers. This means that prices are mainly cost-determined; demand has virtually no influence on prices (except of course by an indirect route in that demand determines the quantities produced, and changes in the latter may have an influence on unit costs). This conclusion emerged both from general observations of how markets operate and from econometric studies such as those by Philip Cagan and William Nordhaus for the United States and Coutts, Godley, and Nordhaus for the United Kingdom. This is a very important result which raises a number of important questions, some of which were considered at some length in Okun’s book, while others, I feel sure, would have been considered by him if he had had the chance to follow up his book with others.

These questions will form the main theme of the second lecture. Some of them are not intended to provide definite answers, but rather to point up the areas of our ignorance. To an extent that is not often realized, or conceded, we do not really know how a modern capitalist market economy works, though given the right orientation for research, it should not prove too difficult to discover the answers.

The Stock-Adjustment Principle

The first and probably the most important conclusion (first stated, I believe, by Professor Kornai*) is that a wholly decentralized system, in which each firm makes its decisions regarding production and purchase quite independently, and reacts only to such signals as are observable within the factory gate, can operate based on information confined to its own sales and changes in its own input and output stock. It is only in regard to the flow of information that different firms are in contact. An order for a certain quantity of a commodity is a communication between two decision makers. This flow of information is linked to the physical flow of products. The information flow is also decentralized; buyer/seller pairs enter into informational contacts separately. Hence it follows that under certain assumptions (which we shall indicate in broad outline), a perfectly decentralized abstract system can operate without price signals, through the operation of the stock-adjustment principle. The main assumption is that each producing unit (each firm) is guided by the desire to maintain a certain normal output stock and a normal input stock. These norms are themselves related to the unit’s sales and to its purchases, which in turn are determined by its own production. When sales increase stocks diminish; this leads to an increase in output with a view of replacing stocks. If the increase in sales is permanent, the increase in production will also be permanent, accompanied by a larger temporary increase until the desired relationship of stocks to sales is regained. Kornai calls this the “vegetative control” of economic processes, referring to the analogy of the special role played by the vegetative nervous system in the function of higher organisms. The role of stocks, as was mentioned in my first lecture, could be replaced by the role of order books; moreover there is nothing to exclude both systems—stocks and order books—playing a role side by side.

Demand-Constrained and Resource-Constrained Economies

To say that production adjusts to quantity signals is not to deny the importance of prices, since the quantity signals themselves are influenced by relative prices, particularly between goods that are close substitutes to each other. The allocation of demand between broad categories of expenditure (such as food, clothing, or housing) is probably not greatly influenced by relative prices, given the same income level. But within each of these groups are subgroups, and subgroups within subgroups, and the narrower the group the more prices are likely to influence the composition of quantity signals. It is through direct or indirect price-advantages that new commodities manage to displace existing ones.

This method of resource allocation presupposes that production in general is demand-constrained and not resource-constrained. It cannot operate in a truly resource-constrained situation since the quantity signals cannot be made effective if there are no inputs available for the adjustment of production. In my first lecture I used the example of a market system turning out doctors, dentists, lawyers, etc. in the right relationships. Neoclassical theory asserts that it is the price system that operates so as to achieve this result. Applicants will flock to the professions where earnings are relatively high, and vice versa, and there is an equilibrium set of relative earnings that will achieve the right numerical relationships. There are a number of difficulties with this explanation, one of which is that differences within a group may swamp any differences between groups. Another is the existence of what Cairnes called “non-competing groups,” which alone can explain why some of the most unpleasant jobs are often the worst paid, instead of the other way round. With the quantity signal principle, people are automatically “slotted in” more or less in proportion to the jobs available, with the next candidate filling the next vacancy. But this presupposes that there is always a queue of people waiting to get jobs (or preferably several queues for different types of labor—skilled, unskilled, highly trained, etc.).

In ensuring a demand-constrained economy, prices have a very important role to play, since the limitation of demand is only ensured by the budget constraint, and the very notion of a “budget constraint” presupposes that different commodities can be brought to a common measuring rod that enables the total purchasing power or buying power to be measured in value terms; it is the relation of the prices of goods to the level of incomes that determines the “budget constraint” of each participant in the market. (Professor Kornai has also introduced the distinction between “hard” and “soft” budget constraints, mainly relating to producers rather than consumers. In a capitalist economy the distinction applies to both.)

As we all know, it was Keynes’s contention that a capitalist economy is normally demand-constrained, whereas the contention of the orthodox economists, whether the Walrasian general equilibrium school or other variants, is that under conditions of competition each resource will be fully employed: whatever unemployment there may be will be voluntary, not involuntary. Are we to take it that the battle between Keynes and the classicists was a sham battle in the sense that while Keynes was fundamentally right that the economy is demand-constrained and not resource-constrained, he was wrong in thinking that it could be anything else in a modern, non-Walrasian economy where prices do not and cannot fulfill a general marketclearing function.

The Role of Disguised Unemployment

The answer to this paradox, I believe, is that an economy does not cease to be demand-constrained merely because it attains “full employment” in some conventionally accepted sense of the term. The main reason for this is that mainly because of imperfect competition there is a large amount of “disguised unemployment” even in the most advanced countries, as shown by the fact that there is always a large queue of people in low-paid jobs who move to higher paid jobs as openings become available. As a result of this the normal response to an increased demand for labor, say in manufacturing, is that there is an automatic transference from low paid jobs in services (the loss of which moreover need not result in any measurable loss of output since it would be offset by the rise in productivity of those remaining in the labor-losing sectors). Imperfect competition has rather different effects in small-scale trades such as cafes, bars, restaurants, or retail shops than in the oligopolies. In small-scale trades the number of units existing at any one time is limited only by the existence of a break-even point. Hence their number tends to be such that there are a proportion of firms that operate at or above the minimum that enables them to cover costs, and not at the maximum set by their capacity. Since labor costs form a large proportion of total costs and labor in these trades is more in the nature of overhead costs, a loss of labor will be associated with an improvement in wages and a corresponding increase in minimum level of sales that cover costs, which means that the same total sales will be distributed among a smaller number of units. A reduction in open unemployment will therefore tend to be associated with a diminution in disguised unemployment that may be quantitatively just as large. (I cannot claim any expertise on the United States economy but it seems to me that one possible explanation of the break in the productivity trend after 1973 was the extraordinary increase in the number of jobs in the consumer service sectors—in restaurants, cafes, and so on—together with stagnant or falling employment in manufacturing.) The usual explanation for all this is that with the progress in real incomes per head, people want fewer goods and more services and that productivity growth in services is notoriously low. It is quite possible, however, that the big rise in employment in small-scale service enterprises was a consequence of a lower overall demand for labor, or a lower demand in the relatively high earning manufacturing industries. If that were the explanation it would show up in enlarged differences between earnings in manufacturing and earnings in services, something that could easily be investigated, if it hasn’t been already. I am not suggesting of course that this could provide the whole explanation. A major part may be due to lower overall growth rates of demand (in real terms) which is associated with lower employment growth as well as lower productivity growth.

This is not to deny of course that the pressure of demand in an economy can become too large, and when this happens it shows itself in the appearance of bottlenecks at various points, increasing delays in delivery, and enforced slackness due to the unavailability of complementary goods. Britain in wartime and in the immediate postwar years exhibited these symptoms, but they appear to be chronic in socialist countries and the cause of a great deal of inefficiency of performance. Professor Kornai attributes this to the absence of effective budget constraints on business enterprises that cannot go bust or be liquidated even though they have continuing losses, as well as to an insatiable appetite for new investment, so that the number of projects started, or in train, generally exceeds the volume initially planned.

Inflation and Employment

In capitalist countries, in my own view, the change is the other way around: the constraints on the pressure of demand tend to be excessive, with the result that unemployment is much greater than can be justified by the needs of resource-allocation, and the rate of economic growth is appreciably less than it could be. The main reason for this is that the distribution of power and, ultimately, the distribution of incomes, changes in favor of labor the faster the economy grows and the nearer it is to full employment, and over a longer period it changes in favor of capital the greater the volume of unemployment. This is the real reason why the continuance of Keynesian policies after the war led to a recrudescence of long-discredited ideas that go by the name of “monetarism.” The main attraction of monetarism was not its intellectual simplicity—inflation is a matter of the money supply, period—but that it elevated the fear of inflation to the unique position which could not be justified by the experience of numerous countries who habitually suffer from it. Thus the presen...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Preface
• I Stylized Facts as a Basis for Theory Building
• II Supply and Demand
• III Interregional Trade and Cumulative Causation