The Structure of Production

New Revised Edition

Mark Skousen

• Publisher: NYU Press
• Year: 2015
• ISBN:
  9781479869954
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

In 2014, the U. S. government adopted a new quarterly statistic called gross output (GO), the most significance advance in national income accounting since gross domestic product (GDP) was developed in the 1940s. The announcement came as a triumph for Mark Skousen, who advocated GO nearly 25 years ago as an essential macroeconomic tool and a better way to measure the economy and the business cycle. Now it has become an official statistic issued quarterly by the Bureau of Economic Analysis at the U. S. Department of Commerce. In this new revised edition of Structure of Production, Skousen shows why GO is a more accurate and comprehensive measure of the economy because it includes business-to-business transactions that move the supply chain along to final use. (GDP measures the value of finished goods and services only, and omits B-to-B activity.) GO is an attempt to measure spending at all stages of production. Using GO, Skousen demonstrates that the supply-side of the business spending is far more important than consumer spending, is more consistent with economic growth theory, and a better measure of the business cycle.

ONE

INTRODUCTION: THE CASE FOR A NEW MACROECONOMICS

If we are witnessing the dissolution of an intellectual establishment, and its fragmentation into conflicting schools, what this eventually leads to—if one reads the history of any intellectual discipline—is the development of a new, comprehensive framework.—Daniel Bell and Irving Kristol, The Crisis in Economic Theory

Macroeconomics needs a new approach. The corpus of contemporary macroeconomic modeling is excessively aggregative, too abstract, and ultimately deficient as a way of analyzing the inner workings of a constantly changing economic landscape. The conventional “neoclassical” models seem almost helpless in rescuing the economy from fundamental structural defects (defects that their macro models are unable to uncover) which have built up over the past fifty years, created by ruinous and vacillating fiscal and monetary policies.1

Orthodox economists have been chipping away at the foundation of these macro models for decades, but have been unable to salvage them. A growing number of economists, recognizing this dilemma, are searching for a workable alternative. With this in mind, I propose an entirely different edifice with which to describe and analyze the production process for the whole economy, a new tableau économique. My method could be called a Mengerian “vertical” framework, which is strictly the opposite of the conventional Clark-Walrasian “horizontal” method, the basis of standard macroeconomics today. I am not suggesting that my task of reconstruction is entirely new or original—it is not—but I have attempted to extend my analysis of the whole economy beyond what has been done in the past in an effort to show how this alternative method is a better and more useful macroeconomic tool for economists than the currently orthodox perspective.

A SHORT CRITIQUE OF CONVENTIONAL MACRO THEORY

Let me be more specific in my criticism of conventional macro theory, and why I think it should be replaced with a new model. Essentially, neoclassical macroeconomics, which forms the foundation of Keynesian, monetarist, and other modern theories, envisions the economy as a collection of large aggregates in a timeless dimension of simultaneous production and consumption. Although its roots can be traced back as far as Adam Smith and the “classical” economists, the modern formula goes back primarily to John Bates Clark, who envisioned the economy as a large reservoir, where the production of goods and services are seen as a permanent, malleable, flowing fund, and to Leon Walras, who saw the economy in a horizontal, timeless fashion where the factors of production were converted instantly into final consumer products.

This Clark-Walras confluence is apparent throughout modern macroeconomic models—in the circular flow diagram, the neoclassical production function, capital theory, the Keynesian consumption function, the monetary “cash balance” effect, and aggregate supply and demand curves.

The standard circular flow diagram, which is used in introductory economics textbooks to describe the interdependence of production, consumption, and exchange, is an abstraction that completely ignores the time element. “It assumes everything is happening at the same time, a false and misleading assumption,” says L. Albert Hahn.2 Moreover, there are no savings, no financial institutions, and no intermediate capital goods of any kind. The circular flow diagram offers no explanation for dynamic changes in the economy—shifts in employment, prices, production, the business cycle, and economic growth, for example.

The neoclassical production function, commonly used in intermediate economics textbooks to analyze changes in output and economic growth, is just as obtuse and barren as the circular flow diagram. The conventional production function envisions the volume of output as a function of inputs, expressed in the form of isoquants, where labor and capital are substituted at varying levels of production.

Michio Morishima is one of many economists who are highly critical of the neoclassical production function, which assumes “that all capital goods are made of putty” that can be combined in any fashion “instantly” and “costlessly.” The concept “is like trying to build a tower on a large anthill.”3 Because the “immobility of capital goods” makes “aggregation” virtually impossible, Morishima rejects the neoclassical model and opts for a “de-centralized” microeconomic approach involving a “vertical genealogy” of product transformation, similar to mine.

Neoclassical capital theory follows the same lines as the production function and the circular-flow diagram. Capital, as characterized by J. B. Clark and Frank Knight, is represented as a permanent homogeneous fund or stock, rather than as distinct commodities of varying age distributions. As such, notes B. S. Keirstead, their theory “not only does not answer the question of what determines the structure of real capital at any time, it does not even permit the question to be asked.”4

Robert M. Solow refers to the permanent fund concept as a “homogeneous jelly,” where capital goods are nonspecific and “instantaneously substitutable” for labor and other inputs. Solow, a principal proponent of the neoclassical position, admits that such an oversimplified view is wrong, especially in the short run.5 Solow is also critical of an attempt by Clark-Knight followers to represent capital models in terms of a single number instead of a variety of heterogeneous goods. “For there is no reason to suppose that any single object called `capital’ can be defined to sum up in one number a whole range of facts about time lags, gestation periods, inventories of materials, goods in process, and finished commodities, old and new machines and buildings of varying durability, and more or less permanent improvements to land.”6

According to F. H. Hahn, the neoclassical models of capital involve numerous unrealistic assumptions, such as: capital lasts forever, there are no intermediate goods, nor is there a time factor, workers do not save, and capitalists do not consume.7

EXCESSIVE AGGREGATION IN MAINSTREAM ECONOMICS

Mainstream economists, still under the influence of Keynes, think in terms of gross national product, the inflation rate, the interest rate, total investment, the unemployment rate, and other singular figures.

For Keynesians, national income is expressed in terms of broad aggregates, as indicated in the well-known consumption function. As Benjamin M. Anderson states, “Throughout Keynes’s analysis he is working with aggregate, block concepts. He has an aggregate supply function and an aggregate demand function. But nowhere is there any discussion of the interrelationships of the elements of these vast aggregates, or of elements in one aggregate with elements in another.”8

Monetarists, with their attention to the real balance effect and the quantity theory of money, are not so distinct from Keynesians in terms of their methodological approach. They also analyze the economy in terms of such broad aggregates as the money supply, the price level, and national output.9 Indeed, the quantity theory of money is expressed mathematically in aggregate form, with single numbers for the money stock, velocity, output, and the price level. According to proponents of the quantity theory of money, velocity is relatively stable, and under full employment the national product is held constant. Hence, the consumer price index is directly correlated to the change in the quantity of money.

Aggregate supply and aggregate demand curves, now a standard method of introducing macroeconomics to students, are only two-dimensional in nature. The economy is neatly fit into an apparatus that links the price level on the vertical axis and real output on the horizontal axis.

Each of these quantities represents large aggregates or averages which completely obscure changes in relative prices, the allocation of resources among various sectors of the economy, and the progressive nature of the production process.10

Kenneth E. Boulding is highly skeptical of macroeconomic models, which he calls an “unworkable fallacy.” According to Boulding, it is essential to realize the “composition” or “structure” of the economy or national income. “It is clearly not merely the aggregate total of production, consumption, and accumulation that matters; it matters what is produced, consumed, and accumulated, i.e., of what goods these aggregates are composed.”11

INPUT-OUTPUT ANALYSIS: A STEP IN THE RIGHT DIRECTION?

In response to these criticisms, economists have been in search of new directions in macroeconomics. One alternative for describing and analyzing the economy has been input-output analysis.

Wassily Leontief suggests the use of input-output analysis as a valuable way of looking at the whole economy, and has written extensively on the subject. According to Leontief, economists should not rely solely on GNP, the interest rate, and price levels, but on the “intervening steps” between inputs and outputs, steps which involve “a complex series of transactions . . . among real people.”12

Input-output analysis appears to be the only major alternative presented by mainstream economists to describe the micro foundations of the economy. Don Lavoie comments, “What is compelling about this approach is that it is, in principle, microscopic rather than macroscopic. That is, it directs attention to the complex details of interdependence of the structure of production rather than to some single-dimensional measure of the size of the nation’s wealth or capital stock.”13

In an input-output table, the horizontal rows show how the output of each sector or industry (agriculture, apparel, vehicles, and so on) is used by the other sectors, while the vertical columns show how each sector obtains from the other sectors its needed inputs of goods and services. For example, the vertical column for the automobile industry shows such inputs as ferrous metals, rubber, electrical equipment, and textiles. These are the basic materials which go into the making of vehicles. The horizontal rows indicate who are the final users of automobiles, trucks, and other vehicles: construction, manufacturing, other industries, and individual consumers.

However, while input-output analysis is a move in the right direction—i.e., as a microfoundation for macroeconomics—it has limitations. The input-output table is essentially only two-dimensional in nature. It links various industrial sectors with their direct factors of production and direct users, but not the indirect, more distant factors. It may demonstrate how shoes come primarily from leather products, but obscures the whole series of processes shoe production goes through, from cowhides to footwear. In short, the input-output (I-O) table does not delineate the entire genealogy of a particular product or industrial sector. It only lists the sector’s close relatives.14

Input-output analysis becomes hardly useful as a macroeconomic tool if one concludes from the I-O table that “everything depends on everything else,” a common interpretation in economics textbooks. In the end, such a holistic notion amounts to nothing more than a homogeneous Clark-Walrasian version of neoclassical macroeconomics.

There has been an effort to rearrange the input-output table according to the natural stages of economic production, “the hierarchy of interindustrial dependence,” as Leontief calls it. This method is termed “triangulation.”15 Sectors are arranged in the upper rows of the table which deliver most of their output to final demand and little to other industrial sectors mor...