Mark-up Pricing in Sweden

Apel et al. (2005) provide data on price setting behaviour in Sweden, from a survey of about 600 private sector firms (Apel et al. 2005: 314) about how the price of their main good was set and with reference to their main type of customers (Apel et al. 2005: 316). Results were also weighted to create a more representative sample of the Swedish economy (Apel et al. 2005: 316).

Unfortunately, this survey suffers from a bad shortcoming: it never bothered to ask if firms set prices on the basis of average unit costs plus a profit mark-up.

Nevertheless, it does report evidence that supports other data from surveys on mark-up pricing.

Apel et al. (2005: 331) find that the “typical” Swedish firm is operating in an oligopolistic market.

When asked to report how often prices were changed, the weighted results were that 40.3% of firms change prices once per year, and 27.1% adjust their prices less than once a year (Apel et al. 2005: 318).

When given a list of reasons for price rigidity, the New Keynesian theories of “menu costs” and “information-gathering costs” ranked as “totally unimportant” and “of minor importance” (Apel et al. 2005: 329).

The survey asked the following question:

“We … asked: ‘Assume that you notice that there has been a slight increase in demand for your main article/service. What is normally the strongest argument for leaving the price unchanged?’ The respondents were given the following alternatives: (1) it is too costly to change the price (relabeling, new price lists, etc.), (2) it is important not to diverge from the prices of competitors, and (3) it is better to leave the price unchanged as long as the costs do not change. An overwhelming majority chose one of the latter two alternatives, with more or less equal shares given to each of these explanations. In fact, the turnover-weighted estimate of the proportion that considered actual costs of changing prices to be the most important factor was 0.2%.” (Apel et al. 2005: 323).

This strongly suggests that cost-based/mark-up pricing was a widespread price setting behaviour that led to these results.

Also consistent with other surveys is that implicit and explicit contracts are important sources of price rigidity (Apel et al. 2005: 324, 327).

In trying to determine whether mark-ups over costs are procyclical or countercyclical, some interesting evidence was found:

“the respondents were asked to rank how well a number of statements described the development of markups over the business cycle. Let us first note that marginal cost is difficult to estimate, except for very simple production technologies, and that firms’ pricing decisions often tend to be based on average variable costs. For this reason, we are unwilling to draw any strong conclusions about how markups over marginal costs develop over the business cycle based on the answers to this question. An increase in marginal costs is clearly associated with an increase in average variable costs, but the relationship between marginal and average variable costs is not necessarily one-to-one. For instance, if we increase quantity so that we move from a relatively flat section of the marginal cost curve to a steeply upward-sloping section, marginal costs will rise sharply whereas average variable costs will only gradually reflect the higher marginal costs.

As reported in Table 5, the most common practice seems to be the use of a constant markup, changing the price proportionally when costs change.” (Apel et al. 2005: 330).

Now the finding that marginal cost is difficult for many businesses to even calculate and that firms face serious “difficulty estimating the marginal cost for all but the simplest techniques” (Apel et al. 2005: 330, n. 20) is consistent with other studies. So too is the finding that price changes in mark-up prices are mainly cost-driven.

But Apel et al.’s implied conclusion that mark-up prices are simply based on “average variable/direct costs” is untrue, and shows how many neoclassical economists who design these surveys do not even understand mark-up pricing conventions. Most mark-up prices are ultimately based on total average unit costs (including both average variable and fixed/overhead costs), because even when mark-up prices are initially based on average variable costs, the crucial point is that the mark-up will include both average unit fixed/overhead costs and an allowance for profit.

That is, while technically in initial “costing,” firms begin with average variable/direct costs, they add average unit fixed/overhead costs to this (Lee 1998: 10, 204–205), so that the fundamental cost concept is total average unit costs.

The failure to understand these facts causes deep confusion, and the utterly unsound idea that the firms simply use average variable/direct unit costs, and that this is a good general proxy for marginal cost. Both ideas are wrong – and this cannot be stressed enough.


BIBLIOGRAPHY
Apel, Mikael, Friberg, Richard and Kerstin Hallsten. 2005. “Microfoundations of Macroeconomic Price Adjustment: Survey Evidence from Swedish Firms,” Journal of Money, Credit and Banking 37.2: 313–338.

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.

Did Anders Borg Pursue Austerity in Sweden in 2009 and 2010?

The right wing press is all aglow with paeans to the Swedish finance minister Anders Borg. See these articles:

Veronique de Rugy, “GDP Growth Rates: The Swedish Approach,” Mercatus Center, May 16, 2012.

Fraser Nelson, “Sweden’s Secret Recipe,” The Spectator, 14 April 2012.

The conservatives appear to be asserting that Sweden’s recovery from the 2008–2009 recession was the result of austerity, and the tax cuts Borg passed in 2007. Unfortunately, this nonsense falls apart when we look at the facts.

Anders Borg became finance minister on 6 October 2006. The government passed tax cuts in January 2007, long before financial crisis of 2008 and global recession. But what kind of tax cut did Borg oversee? Apparently, they involved tax cuts for lower income earners as well as upper income earners:

“What even Borg did not expect was that his tax cut for the low-paid would increase economic growth so much that it has almost entirely paid for itself. Borg had created something that Osborne’s critics say does not exist: a self-financing tax cut. ‘There was some criticism at the time that we were borrowing to finance tax cuts,’ he says. But Sweden could do it, because it was expecting to return to surplus soon.”
Fraser Nelson, “Sweden’s Secret Recipe,” The Spectator, 14 April 2012.

If Sweden was borrowing money to finance tax cuts, then there must have been a resulting deficit, but strangely there doesn’t appear to have been a deficit in 2007:

Swedish Government Budget Surplus/Deficit as % of GDP
2005 1.95%
2006 2.22%
2007 3.53%
2008 2.20%
2009 -1.18%
2010 -1.17%

So I do not know exactly what was going on here: whatever fiscal effect the tax cut had is unclear to me, but the crucial point is that this tax cut happened in 2007.

When the global recession struck in 2008, what did Sweden do? It adopted a Keynesian stimulus package, and expansionary fiscal policy in 2009 and 2010. In December 2008, the Swedish government announced an 8 billion kronor (757 million euros, $966 million) stimulus package, implemented in 2009.

The 2010 budget was also expansionary, and Anders Borg, the man himself, said so:

“Sweden’s centre-right government presented on Monday an expansive 2010 budget bill focused on job creation and economic stimulus to lift Sweden out of the crisis a year ahead of general elections. ‘We are trying to limit damage from the crisis by taking forceful action to promote jobs and enterprise and by providing support to everyone who has been severely hit by unemployment,’ Finance Minister Anders Borg said.”
Economic Stimulus to Lift Sweden out of the Crisis, The Swedish Wire, 21 September 2009.

The Swedish economy was lifted out of its recession around the middle of 2009, owing to the stimulus. The belief that tax cuts in 2007 (whose actual fiscal effects are unclear) caused a recovery in mid-2009 is ridiculous beyond words.

Another ridiculous and misleading trick of conservatives to say that Swedish government spending as a percentage of GDP fell from 52.9% in 2006 to 51.8% in 2011, and then imply that this was the reason for the recovery. Yet the actual figures show a large increase in government spending as a percentage of GDP during the recession and economic crisis:

Swedish Government Spending as % of GDP
2006 52.9%
2007 51.0%
2008 51.7%
2009 55.2%
2010 53.0%

Note the huge surge from 2008–2009 (partly, of course, a function of falling GDP from 2008–2009, but also a result of automatic stabilisers and stimulus spending).

Then the percentage falls once the recovery occurred and the stimulus did its work, causing private sector growth, and rising GDP and tax revenues.

All precisely predictable and consistent with Keynesian economics.

Robert P. Murphy Gets it Wrong on Stimulus in Sweden and the US

Robert P. Murphy has a post here criticising a comment of mine on fiscal policy in Sweden (as compared with the US):

Robert P. Murphy, “Lord Keynes Beautifully Illustrates Why We Get Nowhere in the Stimulus Debate,” Free Advice, 21 May.

Unfortunately, his response is flawed:

(1) the links I cited were to demonstrate that Sweden implemented a stimulus from 2008, not what Murphy says.

The first remarks of Murphy’s post are therefore of no value: it is only Murphy’s erroneous assumption that is at fault here. Murphy assumed, falsely, that my links were meant to prove this idea: “that Sweden is running a budget surplus now is a demonstration that their stimulus worked.” In fact, they were there to prove my assertion that Sweden “passed a large stimulus package in 2008, which continued in 2009 and 2010.” Does Murphy deny this?

Nor did I deny that “the US under any plausible metric ran a bigger Keynesian stimulus than Sweden” – of course it did. That is not the point.

The inference that Sweden’s stimulus worked is my inference, easily confirmed by the fact that

(i) the Swedish stimulus has resulted in real output growth in 2009, 2010, and most of 2011 (which, of course, the links confirm; see here as well) and
(ii) rising tax revenues.

Does Murphy deny either of these two facts?

(2) The whole assumption underlying Murphy’s comparison of the size of the stimulus in Sweden and the US is flawed for the following simple reason: what kind of naive or ignorant person believes that the global recession of 2008-2009 was exactly of the same scale, depth and magnitude in all nations?

What kind of naive person believes that the financial crisis and resulting debt deflationary effects were exactly the same in all countries? Or that the asset bubbles and private debt levels (and resulting private sector deleveraging effects and knock-on effects on the real economy) were all the same?

This is a nonsensical assumption: different countries had different economic conditions, and different crises; consequently, there is no reason why different levels of stimulus will have worked in some nations and not in others. Or why a stimulus of a certain level in Sweden was appropriate there, but not in America. Or why America’s stimulus, even though it was larger than Sweden’s, had different effects too (e.g., not as great an affect on employment).

America had a financial crisis and credit contraction of much greater severity than Sweden. America’s housing bubble and private debt levels are much higher than Sweden’s.

(3) Murphy shows himself incompetent in even understanding basic elements of Keynesian economics. He asserts:

“First let’s consider the deficit as a % of GDP, which is how Keynesians typically evaluate stimulus in the 1930s.”

Um, no, they don’t, Murphy – at least not serious Keynesian economists. How Keynesians “evaluate stimulus in the 1930s” will be find in E. Cary Brown, 1956. “Fiscal Policy in the ’Thirties: A Reappraisal” (American Economic Review 46.5: 857–879): it does not evaluate stimulus in terms of some crude citation of deficits. There is a reason why. It is not the size of a budget deficit per se that will show you if a budget is expansionary or contractionary in terms of fiscal effects. It is perfectly possible to have a budget deficit and have contractionary fiscal policy (as in Ireland and Greece today).

In order to stimulate an economy back to its growth path and potential GDP, one has to do the following:

(i) calculate potential GDP and estimate how severely GDP is likely to collapse by,
(ii) estimate the Keynesian multiplier and
(iii) then design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier.

A great deal of any budget deficit during a recession is merely the result of maintaining spending because of tax revenue collapse.

In both theory and practice, you could have a budget deficit, yet impart zero stimulus to an economy. You can even contract an economy and run a deficit. It beggars belief that a person like Murphy, who sets himself up as some great critic of Keynesianism, appears ignorant of this.

One will need to look at the overall expansionary effect of a budget in terms of its addition to aggregate demand, the most important part of which is how high increases in discretionary spending were.

Sweden and the US both had different recessions. The US had a severe financial crisis. Sweden had no serious financial crisis (see under the heading “Do we have a financial crisis in Sweden?”). America had a huge housing bubble; in Sweden there has been a much smaller real estate bubble and it has not yet burst. Develeraging and debt deflationary effects in America and Sweden have been different. The state of the private sector in both countries is different.

Comparing the size of budget deficits in Sweden and the US does not even show us comparable data for the size of the stimulus in each nation. As a matter of fact, the US stimulus was about 2% of GDP in both 2009 and in 2010. Sweden was much smaller: additional fiscal spending was about 0.38% of GDP (David Saha and Jakob von Weizsäcker, “Estimating the size of the European stimulus packages for 2009,” 20th, February 2009, p. 17).

But then Sweden’s financial sector was not crippled, nor was its private sector in such a bad state as America’s in 2008, 2009 and 2010. It is not surprising that a differently-sized stimulus to that in America worked well in Sweden’s case.

(4) Murphy then cites the overall size of government spending in the economies of Sweden and US, and comes to conclusions so bizarre it so difficult to take him seriously. Here are his data:

Swedish Gov’t Spending as % of GDP
2007: 51.0%
2008: 51.7%
2009: 55.2%
2010: 53.0%

US Federal Gov’t Spending as % of GDP
2007: 19.7%
2008: 20.8%
2009: 25.2%
2010: 24.1%

The fact that Sweden has government spending of over 50% means that its economy was already cushioned from private sector shocks and falls in real output in the 2000s long before the great recession, and certainly to a far greater extent than an economy where it is on the order of 20-25% (like the US).

Sweden’s recovery is thus partly a function of the high degree of government spending (G) in its GDP already in 2008 when its recession struck.

Nor is the particular degree to which government spending rose in each country relevant here: for the US and Sweden experienced different types of recession and thus the degree of stimulus necessary was different in each case (horses for courses, so to speak).

(5) And what is this?:

“Since Sweden handled the crisis much better than the US did, I would say the case of Sweden is prima facie evidence for the Austrian / austerian camp. As always in these matters, these particular data don’t prove anything; maybe there are confounding factors.”

What!? A nation that got out of recession after implementing a stimulus, and where government spending was 51.7% of its GDP in 2008, which then increased to 55.2% in 2009, is “prima facie evidence for the Austrian ... camp.”

Then the whole thing collapses with the words “these particular data don’t prove anything.” What? So what was the point of citing them?

Finally, some questions for Murphy:

(1) Do you dispute that Sweden implemented a stimulus, with expansionary fiscal policy in 2009 and 2010?

(2) Do you dispute that the Swedish recession ended about the middle of 2009 after this stimulus was implemented, and real output growth resumed? If “yes,” then what in your view caused the end of the recession and real output growth that Sweden has had subsequently? Magic?

(3) Do you dispute that the Swedish recovery led to rising tax revenues? That the budget deficit fell?

BIBLIOGRAPHY

Cary Brown, E. 1956. “Fiscal Policy in the 'Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

The Swedish Solution: Sweden’s Bank Bailout versus Japan’s and the US’s

Asset bubbles are a perennial curse in unregulated or poorly regulated financial markets. They are a plague on modern capitalism. But such bubbles, especially ones financed by excessive private debt, were minimized in the period from 1945–1979 when most countries had an effective system of financial regulation.

With the advent of neoliberal/revived neoclassical financial deregulation and liberalization over the past 30 years, asset bubbles and debt deflation have become serious problems again all over the world.

The first major victim was Japan, where ill-advised financial deregulation in the 1980s set Japan up for its massive property bubble that burst in 1991, leading to the lost decade. The US and other countries have now been hit by a similar disaster: bursting housing bubbles financed by high private debt, and leading to debt deflation and private sector balance sheets in a terrible state.

The bailouts in 2008 in the US and the UK and other nations have been widely criticised, and a far better type of bailout was employed by the Swedish government for its financial crisis in 1992. In Sweden, financial deregulation in the 1980s caused a flurry of real estate lending by Swedish banks, and when the bubble finally popped in 1991 and 1992 there was a major economic contraction. Bank failures and a financial crisis occurred. The Swedish solution? Here it is as described in the New York Times:

“Sweden told its banks to write down their losses promptly before coming to the state for recapitalization … later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years …. By the end of the crisis, the Swedish government had seized a vast portion of the banking sector, and the agency had mostly fulfilled its hard-nosed mandate to drain share capital before injecting cash. When markets stabilized, the Swedish state then reaped the benefits by taking the banks public again …. Soon after the plan was announced, the Swedish government found that international confidence returned more quickly than expected, easing pressure on its currency and bringing money back into the country.”
Carter Dougherty, “Stopping a Financial Crisis, the Swedish Way,” New York Times, September 22, 2008.

This type of bailout and cleaning of the financial system was far superior to Japan’s failed bailouts in the 1990s and the US bailout of 2008.

More information on this can be found here:

Peter Thal Larsen and Chris Giles, “Self-assembly solution,” FT.com, March 18, 2009.