Production

Production

SCOPE OF PRODUCTION THEORY

MONETARY THEORY OF PRODUCTION

MARGINALIST THEORY AND ITS CRITICS

BIBLIOGRAPHY

In political economy the term production refers not merely to technical processes but also to the motives and the way human actions are organized to bring the output to existence. Consequently, production is a social process, and a theory of production can be linked to a theory of social development and change. One of the characteristics of production is that it takes time. The Austrian capital theory, and specifically the work of Eugen von Böhm-Bawerk (1889), emphasized the time character of production stemming from the division of labor. Karl Marx emphasized the so-called “realization” problem in his critique of the Say’s Law. John Maynard Keynes extended this problem to the role of uncertainty and expectations in monetary production economy.

The idea that production takes time was common for the Physiocrats, but after Adam Smith (1776) put forward the importance of the division of labor for explaining industrial growth, this concept became central for the argument of roundaboutness of production. Increasing division of labor requires more capital goods, and the production of these lengthens the production process. John Rae (1834) argued that increased division of labor goes together with increased durability of capital and hence longer periods of time required for production. Böhm-Bawerk (1889) conceptualized a “production function” in which he made the level of output obtained per unit of capital a function of the degree of roundaboutness of the production method. He argued that more roundabout methods of production are more capital intensive and therefore more productive. Maxine Berg (1980) connected the shift from concern with the division of labor to fixed capital formation to the social conflict in the early 1830s, which was prompted by technological development and by the so-called “machinery question”—the consequences of implementing radically new techniques and forces of production at the beginning of the nineteenth century.

SCOPE OF PRODUCTION THEORY

With the emergence of the marginalist approach in economics in the nineteenth century, relative prices were put forward as the driving force for change, and the scope of production theory in this tradition became conflated with a theory of exchange. As a contrast, Marx, Thorstein Veblen, Keynes, and Dudley Dillard, among others, focused on “monetary production,” where money is not merely “the great wheel of circulation,” as Adam Smith characterized it.

Marx viewed the relations of exchange as a manifestation of the relations in production, which determine the social, political, and spiritual aspects of life (Marx 1859, p. 100). Although it appears as if exchange, or circulation of commodities, dominates production in capitalist economies, production is the causal force in classical political economy. This is not to say that there is no interaction between exchange and production. As Smith argued in the Wealth of Nations (1776), the division of labor, or production, is limited by the extent of the market (or expanding possibilities for exchange). The point is that the consequence of reducing production relations to the exchange and circulation of commodities explains away the contradictions and conflicts of capitalist production. Marx in Capital, Volume I, made this argument in his critique of Say’s Law (which holds that supply creates its own demand, and there is no possibility of the economy functioning below full employment), and referred to this tradition in economic analysis as “apologetic economy” (p. 114). Not only was production reduced to relations of circulation in this approach, but also circulation was explained as merely the barter of commodities, which is not characteristic for capitalist economies.

In his 1933 article “Monetary Theory of Production” and in the General Theory (1936) Keynes added a distinct component to the circuit theory of capitalist production—production of money by means of money. That component was liquidity preference. Keynes argued that money, with its special properties (low or zero elasticity of production and substitution) is crucial for understanding the changes and direction of output and employment at the macroeconomic level. Thus, he reaffirmed the importance of Marx’s realization problem for understanding a capitalist system.

Keynes recognized that because the decisions to undertake investment had to be made before the results were known, and because the future returns from capital assets would be uncertain, the confidence of expectations in the occurrence of future events becomes important for the occurrence of current investment. As a measure for this confidence Keynes proposed the concept of “liquidity preference” to replace the traditional quantity theory where the rate of interest is determined by “real” factors such as the productivity of capital and thriftiness. As a measure of investors’ confidence in their expectations for the occurrence of future events, liquidity preference determines the price that will be paid to possess money today.

MONETARY THEORY OF PRODUCTION

In a monetary production economy the “return” from holding money comes from its liquidity premium (Keynes [1936] 1964, p. 227). Each asset has an expected total return (an own-rate of interest) composed of q – c + l + a, where q is the expected income from employing the asset in production; c is the carrying cost; l is the liquidity premium; and a is the expected capital gains (appreciation or depreciation). Physical capital will have a return comprised mainly of the yield it is expected to generate from employing it in production. Carrying costs are insignificant for liquid assets, but they would be large for physical capital that depreciates over time. The liquidity premium has two roles: first, protection from future uncertain conditions (expressed through increased liquidity preference); and second, opportunity for profiting from future uncertain conditions (expressed through animal spirits). Expectations about the returns from new investment are compared to those of existing capital, financial assets, and money. The interest rate on money competes with the expected return from employing capital in production—that is, with the marginal efficiency of capital. A situation in which the expected returns of assets are equal, so “that there is nothing to choose in the way of advantage between the alternative” (Keynes [1936] 1964, p. 228), is defined in Keynes’s analysis as equilibrium—a state of rest, not market clearing. In equilibrium the interest rate on money would be equal to the marginal efficiency of capital. But Keynes notes that this does not indicate at what level the equality will be effective. The expected return from holding money as a store of value could be in “equilibrium” (state of rest) with the expected returns from all existing assets at an income below full employment.

Because money is something that cannot be produced, and demand for it cannot be readily choked off, Keynes came to the conclusion that unemployment develops “because people want the moon”—the object of their desire, money, cannot be produced (Keynes [1936] 1964, p. 235). Thus, Keynes’s monetary theory of production explains unemployment not merely through a realization problem (as other economists employing the concept of the circuit do) but through the nature of money and its relation to production and distribution. In the tradition of classical political economy, Keynes’s monetary theory of production emphasized conflict. However, the marginalist schools based on “real-wage” systems demonstrated a harmony of cooperative exchange and equal status of the various revenue shares in production. This is due to the construction of functional relations between quantity consumed and utility on the demand side, and between quantity produced and cost on the supply side, and the resulting symmetry between consumption and production in the marginalist theory (Bharadwaj 1984).

The proposition that capitalists and workers have symmetrical roles in production was put forward by means of conceptualizing their payments as remuneration for their “services” and contribution to production. Profits are viewed as symmetrical to wages as remuneration for the sacrifices of capitalists and as reward for their “waiting,” in the same manner that wages reward labor efforts. Consequently, the distinction between wages and profits is blurred as these are merely returns for homogeneous “factors of production.” The revenue shares are not qualitatively different, as the distinction between the various factors is also obscured. Overall, the shift toward the centrality of individuals’ self-interest and its role in determining relative prices of commodities put forward a conception of an inherently just, value-free mechanism of distribution and production decisions.

MARGINALIST THEORY AND ITS CRITICS

The analytical construct of supply and demand as an explanation of production and distribution was a departure from classical political economy, and it refocused economic theory onto exchange under competition. Increasing returns created problems for the assumption of competition in the neoclassical system, which was pointed out by Piero Sraffa (1926). The possibility for decreasing overhead fixed costs when output increases provides the theoretical possibility for a monopoly, which violates the assumption of competition. The theory of monopolistic competition emerged as an attempt to solve this problem. The theory of diminishing returns is grounded in the supposed technical fact that there is a decreasing productivity of the successive portions of a constant factor of production. The understanding that if more and more inputs are applied to a given piece of land the average output inevitably diminishes has been extended to other factors of production, as well as to the theory of consumption in the form of diminishing marginal utility. The latter is explained by “human nature” rather than technical conditions. Indeed, Sraffa (1926) argued that the same is also valid for diminishing returns, as the producer is the one who ranks the alternative combinations of resources according to their returns. If decreasing returns are not a technical fact, then the producer’s technical choices would not be ranked independently of distribution.

Sraffa critiqued the marginalist theory of production in Production of Commodities by Means of Commodities (1960) on the grounds that diminishing returns to a variable factor presupposes a possibility of substitution, which is problematic when there is heterogeneity of inputs that are also produced. Joan Robinson in “The Production Function and the Theory of Capital” (1953) also pointed out that substitution between capital and labor inputs does not take place within the production process in the way that marginalist theory suggests. Capital inputs are not simply added to or subtracted from other inputs used in production following changes of relative prices. In the marginalist tradition, relative prices then are interpreted as indicative of relative scarcities, instead of being linked to the production process (Roncaglia 1978, p. 92).

A production schema depicts the principal flows of produced goods in the technically required sequence. Such schema has a corresponding quantity model that refers to a precise system of production equations where the level of final demand determines the level of output, intermediate inputs, and labor inputs. The production schema, together with the quantity schema and the pricing model—referring to a precise system of pricing equations—form the price-quantity monetary production model of the economy as a whole (Leontief 1951; Lowe 1976; Pasinetti 1977; Lee 1998).

In the marginalist tradition the profit, often conflated with the interest rate, is presented as the price of a particular commodity—capital, which is subject to the functioning of the supply and demand mechanism. Thus, an increase in the price of capital would bring about an increase in the supply, and a decrease in the demand for this “commodity.” The problem that Sraffa identified and Robinson discussed is that this reasoning presupposes a measure of capital that does not depend on the distribution of income between wages and profits. Sraffa (1960) showed that such a measure cannot exist. Consequently, the linking of variations in output to variations in the quantity of capital and labor utilized in production is undermined. Under these circumstances, profit and wage rates cannot be determined on marginalist principles. Consequently, this critique of capital disputes the harmonious vision of production and distribution characteristic of the neoclassical exchange-based approach, and brings back the issue of conflict within the monetary theory of production.

SEE ALSO Capital; Economics, Keynesian; Economics, Neoclassical; Economics, Post Keynesian; Expectations; Keynes, John Maynard; Labor; Marginalism; Marx, Karl; Profitability; Robinson, Joan; Sraffa, Piero; Technological Progress, Economic Growth; Veblen, Thorstein

BIBLIOGRAPHY

Berg, Maxine. 1980. The Machinery Question and the Making of Political Economy, 1815-1848. Cambridge, U.K.: Cambridge University Press.

Bharadwaj, Krishna. 1986. Classical Political Economy and Rise to Dominance of Supply and Demand Theories. Andhra Pradesh: Universities Press, India.

Böhm-Bawerk, Eugen von. [1889] 1891. The Positive Theory of Capital. London: Macmillan.

Dillard, Dudley. 1980. A Monetary Theory of Production. Journal of Economic Issues 16 (2): 255–275.

Keynes, John Maynard. [1933] 1973. A Monetary Theory of Production. The Collected Writings, vol. 7. London and Basingstoke, U.K.: Macmillan.

Keynes, John Maynard. [1936] 1964. The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace, Jovanovich.

Lee, Fred. 1998. Post Keynesian Price Theory. Cambridge, U.K.: Cambridge University Press.

Leontief, Wassily. 1951. The Structure of American Economy, 1919–1939. White Plains, NY: International Arts and Sciences Press.

Lowe, Adolf. 1976. The Path of Economic Growth. Cambridge, U.K.: Cambridge University Press.

Marx, Karl. [1859] 1999. A Contribution to the Critique of Political Economy, ed. Maurice Dobb. New York: International Publishers.

Marx, Karl. [1867] 1977. Capital. New York: Vintage Books.

Pasinetti, Luigi. 1977. Lectures on the Theory of Production. New York: Columbia University Press.

Rae, John. 1834. Statement of Some New Principles on the Subject of Political Economy. Boston: Hilliard Gray and Company.

Robinson, Joan. 1953. The Production Function and the Theory of Capital. Review of Economic Studies 21: 81–106.

Roncaglia, Alessandro. 1978. The Sraffian Contribution. In A Guide to Post-Keynesian Economics, ed. Alfred Eichner, 87–99. White Plains, NY: M. E. Sharpe.

Smith, Adam. [1776] 1976. An Inquiry into the Nature and Causes of the Wealth of Nations. Oxford: Clarendon Press.

Sraffa, Piero. 1926. Increasing Returns and the Representative Firm. Economic Journal 36 (144): 535–550.

Sraffa, Piero. 1960. Production of Commodities by Means of Commodities. Cambridge, U.K.: Cambridge University Press.

Veblen, Thorstein. 1904. The Theory of Business Enterprise. New York: Scribner’s.

Zdravka Todorova