POST KEYNESIAN PRICE THEORY, IMPERFECT COMPETITION AND THE INSTITUTIONNALIST CONNECTION

Transcription

1 POST KEYNESIAN PRICE THEORY, IMPERFECT COMPETITION AND THE INSTITUTIONNALIST CONNECTION Jordan MELMIÈS 1 Very preliminary draft, do not quote without permission 2 Abstract The aim of the paper is to provide a particular view on the history of thought on prices in Post Keynesian economics. Based on the works of Keynes, Robinson, Kalecki and Means, the article shows that the Post Keynesian price theory followed a specific evolution based on a freeing from marginalist tools and on a connection with the institutionnalist theory. This leads to a reconsideration of what is the Post Keynesian legacy in terms of price theory. 1 PhD student, University of Lille, FRANCE. jordan.melmies@ed.univ-lille1.fr 2 An extended French version exists, downloadable at

2 Introduction Price theory is one of the keystones of standard economic theory. Be it explicit or not, this theory is always based on very precise price determination mechanism. The price of goods and services is determined on a market, which is the unique exchange mechanism. Firms don't take any decision concerning prices: the price is given by the market, or more precisely by an auctioneer as in the work of Walras. The firm then has to decide of the level of output which equates marginal cost with market price. When perfect competition assumptions are not met, firms equate marginal cost with marginal revenue. Firms thus maximize profits. In the neoclassical tradition, the emerging equilibrium price is a relative on: it is defined in terms of another good defined as a standard. As this price is an equilibrium price, markets clear: supply and demand are equal. Some scholls of thought don't share this approach. Among them, the Post Keynesian theory has always been interested in price theory, although macroeconomics have always been dominant. Even if the first source of inspiration of Post Keynesians is Keynes himself, Keynes did not let much work on the building of an alternative way of theorizing price formation, and remained very «marshallian» in his microfoundations. An alternative price theory was not necessary for the Keynesian revolution to accomplish. But his direct successors have taken up the challenge and have brought very important theoretical developments, in particular the imperfect competition theory of Joan Robinson, or Kalecki's degree of monopoly, such that these works are often considered to be the Post Keynesian legacy in terms of price theory and microeconomics. What we want to show here is that Keynes, Kalecki and Robinson started to analyze price formation for very different reasons and from various theoretical starting points, but that they all converged at the end of their career, to a theoretical view which could represent another Post Keynesian legacy on price theory. In our view, they went beyond imperfect competition, and operated a junction with the institutionnalist works of Gardiner Means.

3 I. Various original projects. A. Keynes on price determination. When publishing the General Theory of Employment, Interest and Money» in 1936, Keynes aim at convincing his colleagues that the dominant classical theory in which he was even educated is just unable to explain the world in which they live. And to convince them, Keynes has to stay close to this orthodox theory so as to be able to attack it from inside. Had he proposed a radical and external critique that he would have been immediately blamed for a lot of things and especially for not having understood the essence of the classical theory. To avoid that, Keynes had to make a lot of compromises (Lavoie, 1985). The first compromise he had to make concerns the first chapter, while examining the two postulates of the classical theory, namely the equality between the utility of wage and labour marginal productivity, and the equality between wage utility and labour marginal disutility. Keynes accepts the first, as if he wanted to deeper attack the second one. These compromises allow him to stress on the core of the Keynesian revolution: employment and money. Keynes thus did not explore large areas of economic theory, for example price theory. To build a new theory of prices was not necessary for the Keynesian revolution to accomplish: as Davidson (1984) points out, Keynes' goal was to break Say's law, to show that supply does not create its own demand even with perfectly flexible prices. Keynes thus accepts some common classical assumptions. In the General Theory, he accepts several times the equality between price and marginal cost due to increasing marginal productivity, which makes the supply price increase when production rises (Chap 22). For Keynes, the supply price is made of the product which decides entrepreneurs to provide a volume of employment (chap 4) and the user cost, both divided by quantities. This formulation might seem ambiguous, as Keynes defines the price as the ratio between the monetary amount received from sales on the market and quantities, which is not really a price that would come from adding a profit margin to a measure of costs (in which case it would be the turnover that would be the result of the product of price and quantities). In other words, the price is implicit in the General Theory because it is difficult to distinguish between movements of price and movements of quantities (Barrère, 1985). However the price is still a key variable of the firm: Keynes distinguishes between ex ante price and ex post price. The first is the one at which firms think they can sell all their production. As Keynes assumes profit maximization in a perfect competition framework, firms establish their production plans on the basis of this price they can't change. The ex post price is the realized

4 one. More precisely, this ex post price results from the adjustment between global demand and global supply. If global demand rises, the price will rise. This will affect firms' expectations, who will rise production. Even if Keynes did not have a neoclassical view of price adjustment, he still had an equilibrium price which adjusts to supply and demand disequilibria. Firms did not set prices in the General Theory. B. Joan Robinson and imperfect competition. The theory of price formation was thus not a key issue in Keynes' thought. However, some economists close to him had already been interested in price theory even before the publication of the General Theory. This is the case of Joan Robinson, a friend of Keynes and a member of the «circus». Robinson had published The Economics of Imperfect Competition in In this book, Robinson wants to prove that the size of firms is not limited by the competitive equilibrium and the logic à la Pigou. Robinson had followed Pigou's courses in Cambridge. In Pigou's analysis, firms produce their optimal level of output or don't produce at all. But the crisis in the 1930's precisely showed that a lot of firms were producing below their full capacity without disappearing. It is precisely in order to answer to this problem that the theory of imperfect competition was developed. The main feature of Robinson's book is to analyze firms who, in an imperfectly competitive framework, face a downward sloping demand curve for their own product. Firms thus don't produce the level of output for which marginal cost and price are equal, but the level for which marginal cost equates marginal revenue. This level is below the one that would prevail in a perfectly competitive economy. The Economics of Imperfect Competition had a huge impact. Furthermore, the book showed that in the neoclassical framework, wages are not equal to marginal productivity (Robinson, 1969). C. Kalecki, the degree of monopoly and business cycles theory. At the same time, in Cambridge, an other economist who became one of the best-known Post Keynesians developed his own price theory: Michal Kalecki. For Kalecki, capitalist economies are characterized by oligopoly, monopoly and imperfect competition (Kalecki 1971). His aim seems to have been to develop a theory of the business cycle. As was shown

5 by Kriesler (1987), at the beginning Kalecki's micro theory was destined to explain the rigidity of distribution in face of a change in the level of global demand. For Kalecki (1939), the rigidity of prices can make the degree of monopoly increase after a fall in wages, thus depressing global demand and employment. It is only in 1943 that his micro theory takes the role of explaining economic activity (Kriesler 1987). It determines the level of output for each level of global profit, which is determined by capitalists expenditures. The profit share is determined by the degree of monopoly. This notion of degree of monopoly is central to Kalecki s theory. In his theory, Kalecki analyzes firms that set their prices above marginal cost due to market imperfections. At the beginning Kalecki used a function including price elasticity of demand to link marginal cost and price. But in 1954, admitting that firms don t know neither the price elasticity of demand nor their marginal cost, he replaced these notions by their estimated values by firms. And then he suggested that firms take their average direct cost as a proxy for marginal cost. Kalecki thus develops a price theory based on the concept of degree of monopoly in order mainly to build a theory of the business cycle. Even if he seems to get away from standard theory, his analytical tools remain very close to the marginalist tradition (Kriesler 1987). II. Towards a non-marginalist conception. Until now, we underlined the reasons why Keynes, Robinson and Kalecki were interested (or not) in the theory of price determination. They all have in common to provide an analysis that kept in line with the marginalist theory. What we want to show is that at a certain period of their career, these authors have converged to a non-marginalist way of modelling prices, based on the concept of price policy. The price is then not determined by supply and demand any more. A. Keynes discovering the notion of price policy. In fact, Keynes started to introduce non-marginalist micro-foundations in his theory in A lot of discussions had indeed already confronted him to the theory of the firm and to the problem of price determination. In a letter written the 15/04/1936, one of Keynes friend, F. Gerald Shove, admitted he had enjoyed reading the General Theory but that he thought

6 Keynes was too kind with the classical theory of the firm (CW, XIV, p:1). It is the same with Ohlin, who blamed Keynes for not getting sufficiently far away from conventional assumptions. But the toughest critiques came from R. Hawtrey who blamed Keynes, even since the publication of the Treatise on Money, for assuming that prices immediately adjust to a change in demand, but also for postulating that in manufacturing industry output was determined by prices and profits expectations rather than by current sales (CW, XIII, p: ). Very interesting are also the first drafts of the General Theory. Two 1932 preliminary tables of contents show that Keynes initially wanted to write a part on prices as the third book was destined to be Determination of Prices. But in 1933, the new drafts had abandoned the name of the part, and only one chapter on prices was remaining. In the published version, the only remaining chapter appears into the fifth part of the book. The problem of price determination thus progressively disappeared from Keynes preoccupations. It is only in 1939 that this problem came back in an article in the Economic Journal, in which Keynes discussed the impact of nominal wages upon real wages. In this article, he underlines the fact that producers are more concerned by their long-run average cost than their short-term marginal cost. He thus doubts of the equality between price and marginal cost that prevails in the orthodox theory: Indeed, it is rare for anyone but an economist to suppose that price is predominantly governed by marginal cost. Most businessmen are surprised by the suggestion that it is a close calculation of short period marginal cost or of marginal revenue which should dominate their price policies (CW, VII, p:407). For Keynes, producers maintain their price when output decreases, and don t push it up as much as necessary when output increases. And the reason why firms act like that is quite clear for Keynes: this would quickly lead firms to bankruptcy. Keynes thinks firms operate at a point where marginal cost is decreasing. If this is the case, linking price and marginal cost makes the payment of fixed costs impossible. This leads Keynes to conclude that setting the price in reference to current costs and long term fixed costs is correct and reasonable (ibid.). Keynes thus introduces non marginalist tools in his analysis and underlines the role of pricing policies. This evolution may explain why Robinson and Vicarelli said that there was a Keynesian revolution in price theory just as important as the revolution in employment theory, though Keynes himself did not take much interest in it (Robinson and Vicarelli, 1985). This revolution certainly has something to deal with the fact that it was precisely at this time the famous Oxford economists works were conducted. These works gave birth to the well-known Hall and Hitch 1939 article. This work was among the first to put ahead the

7 fact that entrepreneurs don t seek to maximize profits but rather adopt a rule of thumb and add a profit margin to a measure of full cost. Even if there is no reference to it in the Collected Writings, Keynes was probably aware of its existence and no doubt it did play a role in his own evolution. B. When Joan Robinson abjured. In fact, Joan Robinson made quite the same evolution thirty years after Keynes, in the preface of the second edition of The Economics of Imperfect Competition, in She conceded that she had made the mistake to assume that firms could find the state of demand by successive approximations, and that these price manipulations wouldn t have any impact on the state of the market. To the contrary, she thought that in manufacturing industry, producers set a price and sell all they can to the market. They thus have to define a pricing policy (Robinson, 1969). Two questions can then be asked: first, as she seems to take her distances vis-à-vis the theory of imperfect competition, does that mean she wants to go back to the perfect competition model? She indeed says that a pricing policy in a perfect competition framework could be to set the price in order to sell the level of production corresponding to full employment (ibid.). To the contrary, for her, prices are determined by adding a gross margin to a measure of costs so as to cover overhead costs, amortization and net profit. Prices of manufactured products are thus administered prices. Our interpretation is that one can read in these lines a will to go beyond the theory of imperfect competition, and a call to conceptualize price determination as a process of adding a profit margin to a measure of costs, in a non-marginalist perspective. This process allows for solving some problems of the imperfect competition model: the first is Kalecki s failure to define an industry. The second problem, more recent but very strong, is due to the fact that the imperfect competition model in its basic form is based on a downward sloping demand curve and the elasticity of demand. For the model to be solved, this elasticity has to take values above 1. But a lot of empirical studies on the topic report values below 1 (Lavoie 1992). In the US, surveys conducted by Blinder et alii showed that 20 % of firms were just unable to put a number on this concept, and 60 % reported values below 1, and very frequently just equal to zero! To finish our demonstration concerning Robinson s intellectual evolution, we will refer to one of her last writings, co-authored with Frank Wilkinson (quoted above) in In this text, she clearly sets the difference between sellers and manufacturers. Manufactures are characterized by administered prices based on decomposition between direct and overhead

8 costs and a standard rate of utilization of capacity. For them, this view makes useless the role of the degree of monopoly in the determination of prices. The theory of imperfect competition was just an exit door, but not an arrival point. C. Kalecki, a moderated evolution. We are now going to show that the evolution we underlined in Keynes and Robinson s careers can also be found, although more moderated, in Kalecki s own career. More moderated because he never rejected his previous work, as Robinson and did. But he followed a close way in putting away some of the concepts he previously used. Basile and Salvadori ( ) see three steps in Kalecki s career, but conclude that his price theory did not really change because it is possible to demonstrate that the three steps are equivalent under some assumptions. But we prefer Kriesler s view, who underlined the fact that Kalecki abandoned a lot of concepts through his career. In his first writings, Kalecki used the concept of price elasticity of demand, before replacing it by its estimation by entrepreneurs. Later, this concept plays just an implicit role in the link between average direct cost and average price in the industry. Furthermore, Basile and Salvadori ( ) show Kalecki abandoned at this period any reference to imperfect competition. Finally, in his latest works, Kalecki was just seeing firms adding a profit margin to average direct costs in order to cover overhead costs and generate a profit. He thus converges with Joan Robinson and Keynes vision. Through his writings, one can see that Kalecki abandoned the notion of profit maximization, and he did it for one main reason: radical uncertainty. Behind this fact is the absence of centrally organized markets that allow for market clearing. Third, it is the notion of degree of monopoly that evolved. At the beginning, Kalecki referred to this notion as it was defined by Lerner (1934) which implies profit maximization, which is incompatible with later works (Reynolds 1983)- there was a progressive evolution in the way he defined it (Sawyer 1985). While putting away price elasticity of demand, he introduced advertising expenses and unions power. That makes Basile and Salvadori ( ) conclude that the concept becomes useless because Kalecki went from an observable definition of the degree of monopoly to a synthetic index composed of all factors protecting firms from competition.

9 The moderated style of Kalecki s evolution can be seen through his relations with the Oxford group. Kalecki was living and working in Cambridge at the time of the works. He did agree with the main results but always pointed out the indetermination of the profit margin underlying the theory of full cost pricing (Kalecki 1943). But this does not affect the similarities between his theory and the full cost theory (Sawyer 1985, Lavoie 1992). Last but not least, in 1971, Kalecki distinguished between cost-determined and demand-determined prices. This implies, in our interpretation, a distinction between centralised and non-centralised markets more than a distinction between various degrees of monopoly. III. Gardiner Means and the institutionnalist connection. The Post Keynesian price theory is thus to be understood as the story of a freeing from the marginalist way of thinking and as a convergence to the concept of pricing policy in decentralized markets without market clearing. In fact, when one looks further into this evolution, one will discover that the original source lies in the works of Gardiner Means, an institutionnalist author. This institutionnalist connection differs from the theory of imperfect competition. A. Gardiner Means and administered prices. Keynes and his successors evolution find their real source in Gardiner Means works, well known for his work on control and property in big American companies with A. Berle. Considered institutionnalist, Means achieved important works on the theory of pries. His theory was called the theory of administered prices. But he was not only an academic people. He had worked in business before. His uncle had been known for having launched the Means $4 shoe (Lee 1998). Means distinguished between two sectors in the economy: the first characterized by market prices and the second one characterized by administered prices. In the market sector, prices vary according to supply and demand. This sector is mainly composed of non reproducible goods (for example raw materials). In the administrative sector, prices are administered, set by firms before any transaction takes place. They remain constant for a certain period of time. That means that the equality between supply and demand

10 is not achieved, or only by coincidence. The changes in demand don t affect prices, or just a little. There is no reason why supply and demand should be more equal after a price change than before. Keynes, Kalecki and Robinson (who used the term administered prices in the previous quotes) thus followed a clear convergence to Means works. They converged to a nonmarginalist way of theorizing price formation. To test his theory, Means examined 617 price index series from the BLS. According to him, 131 were market prices, 332 administered prices, the other belonging to no category. Means theory broke with the neoclassical theory in that sense that it underlined a deliberated choice by firms to set prices and to hold them constant (Lee 1998). Another point to underline is that neither Keynes nor Means, (nor Robinson and Kalecki) did think that inflexible prices were more responsible for unemployment. Means was not sure of Keynes position on that point. That s why he decided to visit him in 1939in order to ask him directly (Means 1976). And Keynes answer to this question was always no. The Post Keynesian theory of prices thus operates a junction with the institutionnalist theory of Gardiner Means on administered prices. B. The institutionnalist connection against imperfect competition. What we will defend in this last part is that the institutionnalist connection is in fact playing against the theory of imperfect competition. In other words, the ending point of the Post Keynesian price theory is not imperfect competition. Imperfect competition is not the Post Keynesian legacy in terms of price theory. Means thought administered prices came from administrative control firms had on markets. But he gave up the idea of grounding this administrative control upon monopoly because some firms operating in perfect competition reported administered prices and some monopolies reported market prices. Secondly, despite what he thought himself, Means failed in his attempt to ground administrative control on the degree of concentration, his data allowing for no significant causation (Lee and Downward 1999). He thus grounded it on the size of firms and product characteristics. But in 1938, Tucker had showed that rigid prices did not appear with big companies as Means suggested, but at least in 1790, i.e. that rigid prices seem to be as old as capitalism itself (Tucker 1938). Tucker concluded that the main factor was the way markets are organized: whereas manufactures have to post a price in advance, agricultural prices are for their part not posted in advance but determined on centralised market. This is the same

11 result Means initially suggested: he had remarked that farm products did not have any administered prices, that 85 % of market prices came from newspapers and 66 % of administered prices came from firms direct reports. This confirmed that market prices come from organized and centralized markets more than from markets where competition is imperfect. Conclusion. The Post Keynesian price theory thus followed a specific evolution that is rarely the one put ahead, even by Post Keynesians themselves. This evolution is of course a reconstruction, which is not to be read in the main works of the authors, who started from different starting points, but all converged to the same final point. They gave up the marginalist way of thinking and converged to the institutionnalist conception of Gardiner Means. This connection clearly differs from the theory of imperfect competition. This convergence calls to a reconsideration of the Post Keynesian legacy in terms of price theory.

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