by Utsa Patnaik
The fact that net investment depends upon the level of capacity utilization, increasing when capacity utilization increases and falling when it falls, has two extremely important implications. First, it makes the system unstable. Suppose for some reason capacity utilization happens to fall. Then it lowers investment compared to what it otherwise would have been, which in turn would reduce aggregate demand and hence lower capacity utilization still further. If the economy in the absence of the original fall in capacity utilization would have continued at some particular level of utilization, then it would keep going downhill because of this original fall.
In other words, there may be some level of capacity utilization such that, if the economy happens to be placed at that level, then that level will continue—which is analogous to Roy Harrod’s “warranted rate of growth.” But if the economy deviates from that level then it will go on deviating. That level is then said to have a “knife-edge” property.7
The second implication is that if the economy is in a stationary state, (that is, a state of “simple reproduction” with zero growth) then there is nothing within the system to pull it out of that state. In a world where net investment depends solely upon capacity utilization and is not stimulated by something else from outside this endogenous circle, of demand leading to investment which in turn determines demand, there is nothing to pull the economy out of a stationary state. Put differently, there are endogenous stimuli and there are exogenous stimuli. The former refer to the stimulus for growth in a system that arises because of the very fact of growth having occurred. Endogenous stimuli cannot therefore lift a system out of a stationary state. Exogenous stimuli, by contrast, operate independently of whether growth had been occurring. In the absence of exogenous stimuli, an economy that is at simple reproduction will remain stuck there.
But that is not all. Simple reproduction, or a stationary state, is not someplace at which the economy may get stuck in the absence of exogenous stimuli. It will necessarily get to that state in the absence of exogenous stimuli.8 Given the instability of the system, if the economy is growing then it must be propelling itself forward. In the process it is bound sooner or later to hit some supply-side constraint, either labor scarcity, or a capacity constraint on the production of investment goods that limits investment.9 In such a case, it begins a downward journey which will end only when gross investment equals the level of depreciation, that is, at the stationary state. Once aggregate demand has been factored in, there is no state where the economy can remain perched other than the stationary state in the absence of exogenous stimuli. (The other possible perch, corresponding to Harrod’s “warranted rate of growth,” is, as we have seen, an unstable one, with a “knife-edge” property.)
Because a money-using capitalist economy is characterized by a wealth demand for money and can settle at a state of involuntary unemployment, it also means that in the absence of exogenous stimuli it will move ultimately toward a state of simple reproduction, and remain stuck there.
The three exogenous stimuli that have figured in theoretical discussions are incursions into pre-capitalist markets, state expenditure, and innovations. While the conceptual representation of capitalism in much of economic theory leaves out the first two, since the system is supposed to be isolated and the role of the state is confined to providing law and order and upholding the rules of the game, the last one, innovations, cannot strictly be considered exogenous, even though it has been widely recognized as one.
In a world in which firms cannot simply assume that they face a horizontal demand curve at the going price, which is what “perfect competition,” a mythical state of affairs, entails, they would have to lower their price to sell more. This in turn would invite retaliation from other capitalist firms that do not want to lose their market share. The fact that firms might have unutilized capacity despite the price exceeding marginal cost, the more common scenario, suggests that the fear of retaliation prevents them from attempting to steal market shares from their rivals. Even if a new process or a new product becomes available to a firm, this same fear of retaliation would make that firm use the new process or product in the place of the older process or product to sell only what it would otherwise have sold. Innovation does not make the firm attempt to sell more at the expense of its rivals. It follows that innovation does not per se warrant additional net investment; it contributes to a change in the form of investment (new machines in place of the old).10 An economy stuck in a stationary state cannot hope therefore to get out of such a state even if innovations become available.11
The fact that innovations do not constitute a genuine exogenous stimulus, with the exception perhaps of what Baran and Sweezy called “epoch-making” innovations, such as the railways and the automobiles, is attested to by economic historians.12 The period between the First and Second World Wars had seen the development of several new innovations, but these were not introduced into the production process because of the Depression.13 They got introduced only in the years of postwar boom, which suggests that innovations get stifled in recessions rather than helping overcome recessions.
If the conceptual representation of capitalism prevalent in much of economic theory was correct, then such an economy, being a money-using economy, and therefore capable of settling at a state of involuntary unemployment, would get pushed down toward a stationary state and remain stuck there. Being stuck in such a state, however, is palpably uncharacteristic of capitalism, which underscores the incompatibility between this conceptual representation and its money-using character.
The Value of Money and the Question of Inflation
Let us now turn to another implication of the wealth demand for money. Once it is recognized that there is a wealth demand for money and hence no fixity of ratio between the level of money income and the demand for money, then it necessarily follows that the value of money in terms of goods and services cannot be determined by the interaction between the supply of money and the demand for money arising from the world of goods and services, as is presumed by monetarism and expressed clearly by the Cambridge Quantity Equation.
Let us see what the Cambridge equation says. With the demand for money being equal to k.Y, which can be further split up as k.p.Q where p is the price-level and Q the full employment output (full employment is assured because Say’s Law must hold in the absence of a wealth demand for money), equality between demand and supply in the money market entails that M= k.p.Q where M denotes money supply. The price level p, which is the reciprocal of the value of money, therefore can be said to be determined by the demand and supply of money. And in this case, any rise in money supply results in an equi-proportionate increase in the price level, since Q and k are given. It follows that a rise in the supply of money lowers its value vis-à-vis commodities.
But once we recognize a wealth demand for money, then it follows that a rise in money supply does not necessarily increase, let alone increase equi-proportionately, the price level of commodities in terms of money. In other words, a rise in money supply does not necessarily lower the value of money vis-à-vis commodities. Since the economy is not at full employment, a rise in money supply, if it raises the demand for goods and services at all, can bring forth larger supplies of these goods and services even without any increase in their price, that is, if the marginal cost curve is flat or if price exceeded marginal cost to start with.
Put differently, in the presence of a wealth demand for money, and hence involuntary unemployment, there must be some other rule, other than the demand and supply of money, that must be determining the value of money vis-à-vis goods and services. Both Marx and Keynes, who recognized the wealth demand for money, had correspondingly alternative rules for determining the value of money. In Marx, this rule was provided by the labor theory of value, which held that the value of a commodity in terms of another was determined by the relative quantities of labor directly and indirectly embodied in a unit of each. The value of money in terms of a unit of the non-money comm
odity accordingly was determined by the relative quantities of labor directly and indirectly embodied in a unit of the money commodity compared to a unit of the non-money commodity. (Marx was talking about a commodity money world.) In Keynes, this rule was the fixity of money wages, that is, the fixity of the value of one commodity (labor-power), which goes into the production of all other commodities, in money terms. We will discuss this issue later, but the point here is that in a money-using economy where there is a wealth demand for money and hence involuntary unemployment, there is nonetheless always a determinate value of money in terms of goods and services, even though this is not based on the demand and supply of money.
Likewise, any economy where wealth is held in the form of money and a host of other money-denominated assets also requires that the value of money should be somehow protected. It must not only not fall, for that would have serious consequences for the system, but it must also not be expected to fall, for in such a situation wealth-holders would move away from holding money (and even money-denominated assets) into holding commodities which would impair the money-using character of the system. And since any actual fall in the value of money also generates expectations about a further fall, it becomes all the more important to prevent such an actual fall.
To be sure, some fall, even a steady fall, in the value of money can be taken by the system in stride, as long as the rate of such fall remains below a certain bound. But above a certain threshold, inflation in the prices of goods and services will accelerate as the expected rate of inflation exceeds the carrying cost of goods that can be substituted most readily for money. The value of money in such a case can fall precipitously. Therefore, a money-using economy must ensure that inflation is kept below this threshold, and in general, since nobody quite knows this threshold, as low as possible.
Since a money-using economy typically experiences involuntary unemployment (which coexists with unutilized capacity), and, save in exceptional circumstances such as wars (when there are price-controls and rationing anyway) is scarcely ever supply-constrained, the threat to the value of money arising from an excess demand for the produced goods and services is not very serious, as long as raw materials whose sources are located outside this economy can be obtained at non-increasing prices. (We’ll postpone this last point for discussion later.) The existence of involuntary unemployment, a feature of a money-using economy, itself acts therefore as a means of sustaining the value of money. But even in a demand-constrained system, such as what a money-using economy would typically be, there can be a threat to the value of money arising from conflicts over distributive shares.
Inflation, even accelerating inflation, can occur in an economy nowhere close to full employment. This fact is scarcely recognized in economic theory, even to this day. The monetarists see the economy as spontaneously arriving at a “natural rate of unemployment” that is de facto full employment, and they visualize accelerating inflation if the unemployment rate is pushed below this level and decelerating inflation if it is pushed above. At this level, the economy experiences steady inflation that is determined, leaving aside parametric changes in the income velocity of circulation of money, by the difference between the rate of growth of money supply and the “natural rate of growth” of the economy.14
According to the monetarists’ conception, then, there can never be accelerating inflation when employment is anywhere below this de facto full employment level. And even Keynesians, because of their belief that the capitalist system can be taken close to full employment, do not visualize any serious constraint by way of accelerating inflation before near-full employment has been reached. (Joan Robinson’s “inflationary barrier” was an exception to this, which we discuss later.)15
There is no reason, however, why the level of employment determined by aggregate demand in any period may not be such that money-wage claims, with labor productivity given, must either entail an accommodating reduction in the non-labor share of output, or, in the absence of such an accommodating reduction, an inflation rate that, once it begins to get anticipated, starts accelerating. If there is a reduction in the non-labor share of output with the rise in money wages, then this rise, since it is unaccompanied by a proportionate rise in prices, must entail a rise in real wages.
Thus, in a money-using economy, where accelerating inflation undermines such an economy, a rise in money wages, if it at all occurs, must be accompanied by a rise in real wages to forestall accelerating inflation. Of course, a rise in money wages compared to the previous period, which occurs at exactly the same rate as the rise in labor productivity, leaves the unit labor cost in money terms unchanged. In such a case, even at the same price of the previous period, there will be both a rise in real wages and a maintenance of the non-labor share of output. What we are talking about is a rise in money wages for raising the labor’s share in output. In a money-using economy, if such a rise in money wages occurs at all, then it must lead to a rise in wage-share, because, if it did not, inflation would occur, which would threaten the value of money and hence the wealth held in the form of money and money-denominated assets; and a money-using economy can scarcely tolerate such inflation.
Keynesian economics sidestepped this proposition. Since Keynes believed that real wages equal marginal productivity of labor in “equilibrium” and that the curve for the short-run marginal productivity of labor was downward-sloping, an increase in aggregate demand, which he wanted state intervention to bring about, would raise employment only by lowering real wages. It was essential for the Keynesian position that if employment was to increase a lowering of real wages be accepted by the workers. To buttress his position, he put forward his concept of “money illusion,” namely that as long as the money-wage rate was not cut, then even if there was a cut in the real wage rate through a rise in prices—as would happen when employment and output increase along an upward-sloping marginal cost curve—workers would take little cognizance of it.
This “money illusion” theme was carried forward and given an empirical backing by the Phillips Curve, which suggested on the basis of historical data that the rate of growth of money wages and the unemployment rate had a stable inverse relationship. In effect, no matter what increases in money wages workers demanded and obtained, if these increases were negated through corresponding price rises, the workers took little cognizance of it—and never incorporated the price rises into their money-wage demands. It was “money illusion” in a new garb: workers were satisfied getting money-wage increases, which could be higher at lower levels of unemployment because of their greater bargaining strength, even if these brought no real wage increases.
But this immediately raised the question: What good were trade unions if they did not succeed in raising real wages? And the equally pertinent question: Why were the employers so opposed to trade unions and why did they create so much hullaballoo against them if the unions achieved nothing real?
Michal Kalecki was also deeply affected by this question. He did not accept the proposition that real wages equaled the marginal productivity of labor in “equilibrium.” On the contrary, he had a theory of distribution according to which the share of wages—real wages divided by the (given) labor productivity—was determined by capitalists’ pricing behavior, the markup over the unit prime cost that reflected “the degree of monopoly.” Money wage increases, therefore, could not increase real wages, but could only increase prices, which again raised the question: What was the point of trade unions? The answer given by Kalecki to this question, that the markup itself was constrained by trade union strength, provided no indication of how exactly this came about.16
This question was raised by Ashok Mitra and answered through a theory of distribution of his own, one different from Kalecki’s.17 But the question continued to trouble Kalecki, and he came back to it in one of his last articles, “Class Struggle and the Distribution of Income,”18 where he reiterated, again without explaining exactly how, that trade union action had a role in restraining th
e size of the markup.
But if money-wage increases do not increase real wages but only raise prices, then, in a world where trade unions insist on real wage increases, accelerating inflation would ensue, which is impermissible in a money-using economy. Such an economy therefore must be characterized by the fact that money-wage increases for raising the wage share must give rise to real wage increases that do raise the wage share.
Capitalists, of course, prefer a situation where such money-wage increases do not occur. This is why the system maintains (not necessarily consciously or through deliberate machinations) a substantial level of unemployment, or in Marx’s terminology a “reserve army of labor,” that weakens trade unions adequately. The maintenance of the value of money, in other words, requires the maintenance of a substantial reserve army of labor. But if perchance there is a rise in the money-wage rate for raising the labor-share in output, then the requirement of a money-using economy is that it should give rise to an increase in the real wage rate, and hence in the share of labor in output.
Now, in the conceptual representation of a capitalist economy as consisting only of workers and capitalists, any rise in labor-share can only lead to a fall in the profit share and therefore in the profit rate as well. Hence, if any increase in money wages occurs beyond what the increase in labor productivity allows, then the capitalists have to suffer a fall in profit margin (if accelerating inflation had to be avoided in order to prevent a collapse in the value of money). From their point of view, the best scenario would be if there were no increases in money wages, which means maintaining the size of the reserve army of labor to ensure that there were no such increases. But, for another reason, even this would not be enough. Let us turn to it.