Kalecki, Keynes, Wages and Capacity Utilisation

In this fascinating interview of heterodox economist Bob Rowthorn, he makes a very interesting point about the importance of capacity utilisation and fixprices in Keynesian economics, in terms of the differences between the views of Keynes in the General Theory and Kalecki (N.B. the video may start at an earlier point than I set it at in Mozilla Firefox!).



Now I have not looked carefully into this, but does anyone know any good literature about this subject, and specific references in Kalecki’s work?

The crucial point is that Keynes was opposed to nominal wage cuts (for reasons explained in Chapter 19 of the General Theory), and his analysis there seems to assume a flexprice world (Hayes 2006: 178: “The General Theory itself is a ‘flex-price’ system, but not of Hick’s Walrasian type”) as a concession to the neoclassical theory of Keynes’s day, in order to show that even flexible prices and wages do not necessarily cure unemployment.

But, once we have a mark-up pricing world with adjustments in capacity utilisation where prices are generally relatively inflexible, then expansion of aggregate demand does not simply cause inflation as it would if prices were generally flexprice.

And once we move to the real world of fixprices (the world of mark-up prices and capacity utilisation as in Kalecki’s models), Keynesian economics simply becomes an even stronger and more robust theory of modern market economies.


BIBLIOGRAPHY
Hayes, Mark. 2006. The Economics of Keynes: A New Guide to The General Theory. Edward Elgar, Cheltenham.

Murphy versus Huerta de Soto on the Government’s Ability to Increase Employment and Output

Robert Murphy tells us that it is not at all clear that we “should credit QE1 and/or [sc. the] Obama stimulus” with the US recovery in 2009. That reflects a most extreme view that some Austrians can now be found peddling: the idea that expansionary government fiscal policy does nothing or little to increase private investment and consumption, and that government stimulus programs do not work.

How strange it is, then, to see that other Austrians have never denied that government fiscal and monetary policies can increase employment and output.

Take this statement by Huerta de Soto (who is himself an advocate of a most extreme Rothbardian program):

“Under certain conditions, government and union intervention, along with the institutional rigidity of the markets, may prevent the necessary readjustments which precede any recovery of economic activity. If wages are inflexible, hiring conditions very rigid, union power great and governments succumb to the temptation of protectionism, then extremely high unemployment can actually be maintained indefinitely, without any adjustment to new economic conditions on the part of the original means of production. Under these circumstances a cumulative process of contraction may also be triggered. By such a process the massive growth of unemployment would give rise to a widespread decrease in demand, which in turn would provoke new doses of unemployment, etc. Some theorists have used the term secondary depression to refer to this process, which does not arise from spontaneous market forces, but from coercive government intervention in labor markets, products, and international trade. In some instances, ‘secondary depression’ theorists have considered the mere possibility of such a situation a prima facie argument to justify government intervention, encouraging new credit expansion and public spending. However the only effective policy for avoiding a ‘secondary depression,’ or for preventing the severity of one, is to broadly liberalize markets and resist the temptation of credit expansion policies. Any policy which tends to keep wages high and make markets rigid should be abandoned. These policies would only make the readjustment process longer and more painful, even to the point of making it politically unbearable.

What should be done if, under certain circumstances, it appears politically ‘impossible’ to take the measures necessary to make labor markets flexible, abandon protectionism and promote the readjustment which is the prerequisite of any recovery? This is an extremely intriguing question of economic policy, and its answer must depend on a correct evaluation of the severity of each particular set of circumstances. Although theory suggests that any policy which consists of an artificial increase in consumption, in public spending and in credit expansion is counterproductive, no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion, albeit at the cost of interrupting the readjustment process and aggravating the eventual recession.

Nonetheless Hayek himself admitted that, under certain circumstances, a situation might become so desperate that politically the only remaining option would be to intervene again, which is like giving a drink to a man with a hangover. In 1939 Hayek made the following related comments:

it has, of course, never been denied that employment can be rapidly increased, and a position of ‘full employment’ achieved in the shortest possible time by means of monetary expansion. ... All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period—perhaps the situation in which Dr. Brüning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.

Now let us suppose politicians ignore the economist’s recommendations and circumstances do not permit the liberalization of the economy, and therefore unemployment becomes widespread, the readjustment is never completed and the economy enters a phase of cumulative contraction. Furthermore let us suppose it is politically impossible to take any appropriate measure and the situation even threatens to end in a revolution. What type of monetary expansion would be the least disturbing from an economic standpoint? In this case the policy with the least damaging effects, though it would still exert some very harmful ones on the economic system, would be the adoption of a program of public works which would give work to the unemployed at relatively reduced wages, so workers could later move on quickly to other more profitable and comfortable activities once circumstances improved. At any rate it would be important to refrain from the direct granting of loans to companies from the productive stages furthest from consumption. Thus a policy of government aid to the unemployed, in exchange for the actual completion of works of social value at low pay (in order to avoid providing an incentive for workers to remain chronically unemployed) would be the least debilitating under the extreme conditions described above.” (Huerta de Soto 2012: 452–456).

First, before I come to my main point, Huerta de Soto is entirely wrong to blame “secondary depressions” solely on government intervention and “union power.” Has this man never heard of debt deflation and subjective expectations affecting the outlook of capitalists? In an environment of high private-sector debt, wage cuts would prove disastrous as the burden of debt soared, which causes bankruptcy to both debtors and creditors. And, in any case, markets lack the reliable equilibrating mechanisms so beloved by neoclassicals and Austrians, for the following reasons:

(1) the essential property of all highly liquid assets (with money as the most liquid asset) is that there is a zero or near zero elasticity of substitution between these liquid assets and producible commodities. This means that the gross substitution axiom is false and any acts of spending on liquid assets causing their price to rise will not necessarily induce substitution effects leading to more demand for cheaper producible commodities.

(2) it is unlikely that all markets have equilibrium prices (and even less likely that price setting businesses would be willing to adjust the prices rapidly anyway if they existed). The very notion of an economy with a tendency to general equilibrium, where all product markets converge to market-clearing prices, depends on unrealistic assumptions, such as flexible prices and demand and supply curves behaving with substitution effects in the absence of income effects;

(3) owing to uncertainty and subjective expectations, it is unlikely that shattered expectations of business people will change suddenly to induce the necessary level of investment in a severe recession or depression;

(4) there is thus no guarantee that savings will match investment (even if you assume a loanable funds theory of interest) or that Say’s law is much more than a fantasy;

(5) there is no such thing as some natural rate of interest that will equilibrate savings and investment;

(6) as Keynes himself argued, absence of wage and price flexibility is not the reason why neoclassical theory is flawed: even if we had complete wage and price flexibility, there would still be no guarantee of full employment.

But to return to my original point: the crucial issue here is that even Huerta de Soto states that “no one denies that, in the short run, it is possible to absorb any volume of unemployment by simply raising public spending or credit expansion” – no one, that is, except (apparently) Robert Murphy!

Curiously, Ludwig Lachmann went further than Huerta de Soto and saw public works spending in a depression as a genuinely useful measure:

“In the British situation of 1932, Hayek and his friends rejected the proposals of Keynes and some non-Keynesian British economists – that at the bottom of the depression the government should take certain steps, and so on. Hayek has now realised that that was wrong. That is to say, I think Austrians today would not reject all measures to relieve unemployment and increase employment, in a situation in which nothing really is scarce. And in this respect I think Austrians … would have … have ... learned.”

BIBLIOGRAPHY

Huerta de Soto, J. 2012. Money, Bank Credit and Economic Cycles (3rd edn.; trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Money: Is it Wealth?

The view that money is not wealth isn’t new. Adam Smith held this view:

“The great wheel of circulation [= money] is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel [= money] which circulates them” (Smith 1811: 202).

Thus money is not synonymous with wealth, and money cannot be consumed in the way that commodities can. There is a widespread belief that real wealth is goods and services available in a nation, though it is sometimes unclear whether this definition of wealth includes real assets like housing or commercial property.

Libertarians are fond accusing Keynesians of saying that “money is wealth” or that “money creation is wealth creation.”

This is, of course, a caricature. One can readily agree that money is not wealth. Money is (1) a unit of account, (2) a medium of exchange and (3) a store of value.

In this role, money is (1) a claim on output or (2) a future claim on output (commodities). However, money does have utility on its own account. People can desire to hold money as hedge against future uncertainty, but even here one can say that this is because of its store of value function that allows purchasing power to be used in the future.

Libertarians frequently invoke one aspect of Say’s law of markets which states that people need to engage in production before consumption. In other words, consumption of commodities must have prior production (at home or overseas). This is certainly true. What does not follow is that supply (total factor payments from production) will equal consumption or investment. Aggregate demand failures can in fact occur.

Now money is a unit of account and medium of exchange (also a store of value): but as a unit of account and medium of exchange it is a thing that facilitates exchange and production. One can agree that money itself is not wealth in the sense that is not identical with commodities, but is a claim on commodities.

In a recession, there are idle resources and capacity utilization has fallen. But the nation’s ability to produce things is not fundamentally impaired. Factories might be idle or running at 50% or 70% capacity with space for further production, and unemployment (idle labour) might be high.

Wealth creation done in the private sector is facilitated by Keynesian macroeconomic management of the economy, and in particular by ending recessions.

Deficit spending in a recession is a way of mobilizing idle resources like labour for creation of public infrastructure. Actual production (= wealth creation) is facilitated in the private sector by paying idle workers money as wages to allow them to consume from the private sector or by payment by government for other commodities from the private sector.

A similar process would occur even if the spending was done privately. For example, if a private businessman decided to build a railway in an area where it was needed, the money for the construction would came from a private loan, and the economic activity that resulted would increase private sector production through idle workers using money wages for consumption and the use of other commodities from the private sector in construction of the railway.

While deficit spending normally involves creation of public infrastructure and not factories or new capital goods directly, the use of idle resources and payment of wages increases demand for commodities. This process increases production (say, by raising capacity utilization) and leads to an expansionary phase of the business cycle where new business and factories are created to expand output.

A recession by definition means idle resources, lower capacity utilization, and unemployment. Deficit spending just puts those idle resources to work. Production increases in the private sector when orders come in, employment falls, people are free to buy what commodities they want by deciding on the basis of subjective valuation.

Far from thinking of money as “wealth,” Keynesians can easily conceive of money as the tool that facilitates production and creation of wealth. There is no contradiction here with the proposition that real wealth is only output.


APPENDIX 1: HENRY GEORGE’S DEFINITION OF WEALTH

I do not follow or endorse the economics of Henry George, but he had an interesting view of wealth that is worth discussing. I quote from a summary of how Henry George defined wealth in his book Progress and Poverty:

All material things produced by labor for the satisfaction of human desires and having exchange value. This means that wealth must have all of these characteristics:

1. Wealth is material. Human qualities such as skill and mental acumen are not material, hence cannot be classified as wealth.
2. Wealth is produced by labor. Land possesses all the essentials of wealth but one -- it is not a product of labor, therefore it is not wealth.
3. Wealth is capable of satisfying human desire. Money is not wealth; it is a medium of exchange whereby wealth can be acquired. Nor are shares of stock, bonds or other securities classifiable as wealth. They are but the evidences of ownership. None of these satisfy desire directly; if they are destroyed, the sum total of wealth is not decreased.
4. Wealth has exchange value.”
http://www.henrygeorge.org/def2.htm

It is unclear how production of services fits into this, but it appears to me that a good many libertarians view wealth in a way similar to that of Henry George.


BIBLIOGRAPHY

Montes, L. and E. Schliesser (eds), New Voices on Adam Smith, Taylor & Francis Ltd, Hoboken. 225

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.