Do Modern Austrians ever Read Lachmann?

For example, this passage:

“In neoclassical equilibrium theory the relationship between value and price becomes problematical in a way it was not for classical economists. The difference is one of the knowledge we may attribute to market participants. In the classical world it was reasonable to assume that every trader in a market knew the long-run cost of production of the product traded and was able to make use of this knowledge in dealing with day-to-day price fluctuations. But neoclassical equilibrium rests on a complex interplay of demand and supply in thousands of markets. In the absence of ‘The Auctioneer’ nobody can ‘know’ an equilibrium price until the system as a whole has attained this position. Traders are unable to compare current prices with a ‘long-run normal price’ as they do not know the latter. The problem of price formation arises in a new form. The day-to-day conduct of traders requires a new form of explanation.

It is therefore not surprising that a fairly straight line links Mayer’s position to contemporary discussions of fixprice and flexprice markets, two terms we owe to Sir John Hicks. Once we realise that in our world all prices are disequilibrium prices, the problem mentioned above arises on many levels. It was to be expected that post-Keynesians would seek guidance in the writings of Keynes who, in any case, distrusted neoclassical theory. Chapter 29 of the Treatise on Money may be said to contain a rudimentary theory of price formation in conditions of disequilibrium. A few years ago Professor Davidson made a notable attempt to take Keynes’s thought on price formation in different markets a little further by distinguishing between ‘produce-to-market’ and ‘produce-to-contract’ entrepreneurs (Harcourt (ed.) 1977:313–17).

In different markets prices are formed in different ways. Not all pricefixing agents have the same interests. Here historical change plays its part. The decline of the wholesale merchant, whose dominating role Marshall took for granted, for instance in textile markets, and who naturally aimed at setting such prices as would permit him to maximize his turnover (a short-run consideration), reduced the range of markets with flexible prices. The rise of the industrial cost accountant as a pricefixer, with his interest in ‘orderly marketing’ (a long-run consideration) and his aversion to frequent price changes, has made most prices of industrial goods in our world Hicksian fixprices. In all markets dominated by speculation of course prices must be flexible. On the other hand, all bureaucracies, including those concerned with production planning in large industrial enterprises, naturally abhor flexible prices. ... .” (Lachmann 1994: 165–166; originally published in Lachmann 1982).

And a further observation:

“Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants.

The analytical significance of this historical change lies, on the one hand, in the fact that the ‘Temporary Equilibrium Method’ which Hicks himself, following Lindahl, used in Value and Capital in 1939, has lost much of its validity. ‘The fundamental weakness of the Temporary Equilibrium method is the assumption, which it is obliged to make, that the market is in equilibrium—actual demand equals desired demand, actual supply equals desired supply—even in the very short period.’ (76) Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).

One will look in vain for a discussion of these issues in other Austrian literature, apart from a scant discussion in Reisman (1996: 414–417).

But none of the modern Austrians – not even Lachmann – bothered to properly think through the implications of administered prices.

If they had, they would have seen that the central plank of the Misesian theory of economic coordination – that the market, even an “unhampered” market, has a strong tendency to market clearing and full use of resources – must be abandoned.

BIBLIOGRAPHY
Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.

Lachmann, L. M. 1982. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” Journal of Institutional and Theoretical Economics 138.4: 629–645.

Lachmann, L. M. 1994. “The Salvage of Ideas: Problems of the Revival of Austrian Economic Thought,” in D. Lavoie (ed.), Expectations and the Meaning of Institutions: Essays in Economics. Routledge, London. 159–178.

Reisman, George. 1996. Capitalism: A Treatise on Economics. Jameson Books, Ottawa, Ill. and Chicago.

Salerno on Market-Clearing Prices in Austrian Theory

Joseph T. Salerno describes it here in his comments on the role of “price coordination”:

“Price coordination must not be confused with plan coordination, a concept originally formulated by Friedrich von Hayek. In his article ‘Economics and Knowledge,’ which has heavily influenced modern Austrian writers, Hayek suggested a concept of equilibrium based on ‘coordination of plans’ as a substitute for the concept of equilibrium based on ‘constancy of the data.’ In contrast, price coordination, as I elaborate the concept below, is the indispensable complement to the concept of an evenly rotating economy based on constant data. As Ludwig von Mises has repeatedly emphasized, the evenly rotating economy, although an imaginary state which can never be realized in the unfolding of the historical market process, is yet indispensable to the identification and analysis of the entrepreneurial function of the real world.

Entrepreneurs, however, can formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices which, at every moment of calendar time and without fail, reflect, promote, and coordinate those uses of the available scarce resources that are expected to be the most highly valued by consumers. Price coordination, therefore, is not a phenomenon associated with an unrealizable state of equilibrium, however the latter is conceived; rather, price coordination is the essential characteristic of the plain state of rest, which, as Mises tells us, ‘… is not an imaginary construction but the adequate description of what happens again and again on every market.’” (Salerno 2010: 182–183).

The absurdity of this passage takes one’s breath away.

First, although there is sometimes confusion about whether Austrian price theory is meant to be merely an ideal or prescriptive vision of economic coordination, here it seems that flexible prices moving towards their market clearing values is meant to be a descriptive theory describing how real world markets actually function (although of course it can be a prescriptive and ideal vision at the same time, as, for example, when Austrian think governments or unions are supposed to interfere with the system of flexible prices).

Secondly, can entrepreneurs “formulate and execute production plans only in a world in which economic calculation is possible, that is, in which catallactic competition generates market-clearing prices”? Of course, Salerno’s phrase “generates market-clearing prices” can be understood to mean prices that move towards their market-clearing values (or the “equilibrium prices” at which demand and supply are equal), and not that all prices do indeed reach such equilibrium values, since he rejects the real world existence of equilibrium states (such as Walrasian general equilibrium or the Misesian final state of rest).

But is successful capitalist production only possible in a world generating and moving towards market-clearing prices? The answer is, of course, no.

So much of any real world capitalist economy consists of fixprice markets with administered prices, where private businesses shun flexible prices in the conventional sense. Yet production continues, economies can have strong and indeed historically unprecedented real GDP growth, employment can be high, living standards and real wages can rise significantly, and productivity growth can be strong. We need only think of the golden age of capitalism from the 1946–1970s period.

The Austrian notion that capitalist economies can only work successfully with flexible prices and a tendency to market clearing prices is wrong, absurd and contrary to empirical reality.

BIBLIOGRAPHY
Salerno, Joseph T. 2010. Money, Sound and Unsound. Ludwig von Mises Institute, Auburn, Ala.

Lachmann on Hicks on Fixprices

Sir John Hicks’s book Capital and Growth (Oxford, 1965) has an important discussion of the history of fixprices.

The significance of that discussion is described by the Austrian Ludwig Lachmann in a review of article of Capital and Growth:

“Two other matters of great significance are dealt with in the first part of the book. As others have done before him, Professor Hicks finds it necessary to stress, in his chapter on Marshall’s method, that our world differs from that which Marshall took for granted in that we live in a world of prices ‘administered’ by manufacturers, ‘but in those days even manufactured goods usually passed along a chain of wholesalers and retailers, each of whom was likely to have some independent price-making opportunity.’ (55) Again, like others before him, our author attributes the cause of this change to the virtual disappearance of the wholesale merchant and his price-setting function after 1900. Formerly ‘the initiative would come from the wholesaler or shopkeeper, who would offer higher prices in order to get the goods which, even at the higher price, he could re-sell at a profit. Similarly, when demand fell, it would be the wholesaler who would offer a lower price. The manufacturer would have to accept that price if he could get no better.’ (56) Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants.

The analytical significance of this historical change lies, on the one hand, in the fact that the ‘Temporary Equilibrium Method’ which Hicks himself, following Lindahl, used in Value and Capital in 1939, has lost much of its validity. ‘The fundamental weakness of the Temporary Equilibrium method is the assumption, which it is obliged to make, that the market is in equilibrium—actual demand equals desired demand, actual supply equals desired supply—even in the very short period.’ (76) Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).

Lachmann was well aware of the significance of fixprices, and discussed them in The Market as an Economic Process (Oxford, 1986), pp. 122–136.

Lachmann stated:

“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).

Lachmann even concluded that his own fellow Austrians had badly neglected the task of studying real world price formation (Lachmann 1986: 130–131).

That is a failing that most Austrians are guilty of to his day, despite some discussion of the issue in Reisman (1996), pp. 414–417, where Reisman does not consider the implications of cost of production plus profit mark-up pricing for Austrian theories of economic coordination.

Links
“Lachmann and Post Keynesianism on Prices,” August 1, 2012.

“Mises versus Lachmann on Equilibrium Prices,” December 17, 2012.

“Caldwell on Lachmann on Equilibrium Prices,” November 6, 2012.

“Kaldor on Economics without Equilibrium,” March 9, 2013.


BIBLIOGRAPHY
Hicks, John Richard. 1965. Capital and Growth. Oxford University Press, Oxford.

Lachmann, Ludwig M. 1966. “Sir John Hicks on Capital and Growth,” South African Journal of Economics 34: 113–123.

Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.

Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.

Reisman, George. 1996. Capitalism: A Treatise on Economics. Jameson Books, Ottawa, Ill. and Chicago.

Early Literature on Administered Pricing

Two standard works on Post Keynesian price theory are Downward (1999) and Lee (1998).

But administered pricing has been recognised and studied by economists since the 1930s, and the literature is vast. Below is a sample of the important early literature on fixprices and administered pricing:

(1) Gardiner C. Means

Berle, Adolf A. and Gardner C. Means. 1932. The Modern Corporation and Private Property. Macmillan, New York.

Means, G. C. 1992 [1933]. “The Corporate Revolution,” in Frederic S. Lee and Warren J. Samuels (eds.), The Heterodox Economics of Gardiner C. Means: A Collection. M.E. Sharpe, Armonk, N.Y.

Means, G. C. 1935. Industrial Prices and their Relative Inflexibility. US Senate Document no. 13, 74th Congress, 1st Session, Government Printing Office, Washington DC.

Means, G. C. 1936. “Notes on Inflexible Prices,” American Economic Review 26 (Supplement): 23–35.

Means, G. C. 1939–1940. “Big Business, Administered Prices, and the Problem of Full Employment,” Journal of Marketing 4: 370–381.

Means, G. C. 1962. Pricing Power and the Public Interest. Harper and Brothers. New York.

Means, G. C. 1972. “The Administered Price Thesis Reconfirmed,” American Economic Review 62: 292–306.

Gardiner C. Means studied price setting by modern corporations in the United States, and was one of earliest and most important economists who examined administered pricing. He concluded, after extensive empirical research, that prices of goods produced in many corporations are set by a mark-up on cost of production (Downward 1999: 50).

He was clear that the neoclassical price theory with its ideas of flexible prices adjusted by agents in auction or auction-like transactions is not a description of reality for most markets:

“Basically, the administered-price thesis holds that a large body of industrial prices do not behave in the fashion that classical theory would lead one to expect. It was first developed in 1934–35 to apply to the cyclical behavior of industrial prices. It specifically held that in business recessions administered prices showed a tendency not to fall as much as market prices while the recession fall in demand worked itself out primarily through a fall in sales, production, and employment.” (Means 1972: 292).

“Fourth, the actual behavior of administration-dominated prices … tends to differ so sharply from the behaviour to be expected from classical theory as to challenge the basic conclusions of that theory. However well the theory may apply to market-dominated prices, it would not seem to apply to the bulk of the administration-dominated prices in the sample or to that part of the industrial world which they typify.

Until economic theory can explain and take into account the implications of this nonclassical behavior of administered prices, it provides a poor basis for public policy. The challenge which administered prices make to classical economics is as fundamental as that made by the quantum to classical physics.” (Means 1972: 304).

(2) Hall and Hitch

Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.

Hall and Hitch were part of the Oxford Economists Research Group and postulated a “full cost” theory of pricing, plus mark-up for profit (Downward 1999: 46). Mark-ups are constrained to some extent by competing businesses.

(3) Michał Kalecki

Kalecki, M. 1939. Essays in the Theory of Economic Fluctuations. Allen and Unwin, London.

Kalecki, M. 1939–1940. “The Supply Curve of an Industry under Imperfect Competitions,” Review of Economic Studies 7: 91–112.

Kalecki, M. 1954. Theory of Economic Dynamics. Allen and Unwin, London.

Kalecki, M. 1971. Selected Essays on the Dynamics of the Capitalist Economy. Cambridge University Press, Cambridge.

Michał Kalecki (1939) treats fixprices as set by means of production costs and profit. He also noted the important role of excess capacity in industries. Hall and Hitch’s work influenced Kalecki’s views on prices (Downward 1999: 51).

In Kalecki (1954 and 1971), he developed his theory of prices. He divided prices in market economies into two types, as follows:

(1) cost determined prices; and

(2) demand determined prices.

Most finished goods are cost determined, while many raw materials and primary commodities are demand determined (that is, flexprice markets).

Most manufactured goods have prices that are cost determined. Prices are set under conditions of uncertainty and, crucially, profits are not, strictly speaking, maximised in the neoclassical sense (Downward 1999: 52).

Normal price floors are set by costs of production, and ceilings – at least to some extent – by the average price level in the particular industry concerned.

(4) P. W. S. Andrews

Andrews, P. W. S. 1949 “A Reconsideration of the Theory of the Individual Business,” Oxford Economic Papers n.s. 1.1: 54–89.

Andrews, P. W. S. 1949a. Manufacturing Business. Macmillan, London.

Andrews, P.W.S. 1964. On Competition in Economic Theory. Macmillan, London.

Andrews noted the existence of excess capacity in many firms and how administered pricing is often normal even in markets where competition exists, or that is, “irrespective of the degree of competition which the firm has to meet” (Andrews 1949: 58–59). When firms wish to increase market share, it will often be by means of superior quality and reputation, rather than price cuts (Downward 1999: 50).

Finally, I note how John Kenneth Galbraith in his own important work on administered prices also drew on this earlier literature, particularly Berle and Means and Kalecki (Dunn 2011: 144, n. 46).


BIBLIOGRAPHY
Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Northamption, Ma.

Dunn, Stephen P. 2011. The Economics of John Kenneth Galbraith: Introduction, Persuasion, and Rehabilitation. Cambridge University Press, Cambridge and New York.

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