“Introduction to Post-Keynesian Economics”, part 1: On Orthodoxy and Micro

Intro

Lavoie was inspired to write this book after a visit to France. In bookstores, he found many economics books condemning “what the French call ‘la pensée unique’ (the single thought), or what the English-speaking world knows as ‘There Is No Alternative’ (TINA)”. The latter was a slogan popularized by Margaret Thatcher, claiming that free markets, free trade, and austerity were the only serious policy option. However, Marc found that these books didn’t present a coherent alternative to the neoclassical theories that supported TINA. Instead, many economists simply created more sophisticated neoclassical models, rather than starting from a fundamentally different basis. That basis, to be presented here, is post-Keynesian economics.

  • Higher demand always leads to higher prices.
  • Higher real wages increase unemployment or decrease profits.
  • Lower savings leads to lower investment or growth.
  • Budget deficits lead to inflation and a rise in the interest rate.

1. Post-Keynesian Heterodoxy

1.1: Who are the post-Keynesians?

Heterodox economics is a big tent, encompassing Marxists, Sraffians, neo-Structuralists, Institutionalists, and more. Each of these schools focuses on different areas of the economy, with different core texts and sources of inspiration. Post-Keynesianism has its origins in John Maynard Keynes’ work, especially his book “The General Theory of Employment, Interest and Money”. Crucially, they interpret this work very differently than the neoclassical synthesis Keynesians (like Paul Samuelson and James Tobin) or the new Keynesians (like Gregory Mankiw, Alan Blinder, and Joseph Stiglitz). [For an in-depth post-Keynesian interpretation of “The General Theory”, I highly recommend Alex Williams’ ongoing series here]. Core post-Keynesian ideas also come from contemporaries of Keynes like Joan Robinson and Roy Harrod, as well as neo-Marxist Michał Kalecki, neo-Ricardian Piero Sraffa, and Institutionalists like Thorstein Veblen and John Kenneth Galbraith.

1.2: The characteristics of heterodox economics

To delineate heterodox and orthodox approaches, we should start with presuppositions on how economic questions should be approached. Don’t worry, I’ll explain all the big words shortly.

1.3: The essential characteristics of post-Keynesian economics

Now that we’ve broadly compared heterodox and orthodox approaches, one might ask: what distinguishes post-Keynesianism? Two principles are essential, while five more are auxiliary.

1.4: The various strands of post-Keynesian theory

A natural result of a realist approach is to draw from several different theories, as different parts of the economy simply act differently. So, post-Keynesian theory “is far from being a homogeneous approach”. But three main strands stand out.

2. Heterodox Microeconomics

Post-Keynesianism disagrees with 2 core elements of neoclassical microeconomic theory. First is marginalism, the idea that price is related to marginal utility (the usefulness of one additional good). Second is decreasing marginal utility: that each additional unit of a good is slightly less useful.

2.1 Consumer choice theory

The origin of post-Keynesian micro theory is in marketing and psychology. Rather than starting from abstract assumptions, it starts from observations about actors in the real economy. Post-Keynesianism makes a distinction between needs (which can be ranked and prioritized) and wants (preferences within a category). For example, you might need a drink more than you need to eat, but want ginger ale more than you want water. Given that basis, we can now discuss 7 principles of post-Keynesian consumer choice theory.

  1. Procedural rationality means consumers will tend to follow habits and find shortcuts in making consumption decisions. Instead of maximizing utility, as in neoclassical approaches, they instead satisfice.
  2. Wants are satiable. Beyond a threshold, more of a good won’t bring additional satisfaction. Compare this to neoclassical models, where more of a good always brings somewhat more utility.
  3. Needs are separable into different categories. Taking into account comparisons of all goods on the market would be hard. Instead, consumers allocate a certain amount of money to each category. What they buy in that category then depends on relatives prices of those goods, rather than the relative prices of all goods. Studies back this up: “the price elasticities for major subgroups are extremely weak (between –0.003 and –0.072 according to one such study) and cross-price elasticities close to zero (in fact, inferior to 0.02, 30 out of 36 times; see Eichner, 1987, ch. 7)”.
  4. The subordination of needs, which is similar to Maslow’s hierarchy of needs. Income goes to one type of need until it is satisfied, then remaining money goes to the next level, and so on. Changes in relative prices within a level only change consumption of goods in that level.
  5. As someone’s income grows, their level on the pyramid of needs increases, with the top level being moral and environmental needs.
  6. Pulling from Galbraith, post-Keynesians believe needs are determined by marketing and imitation of others.
  7. Consumer’s choices are not independent of order, but depend on past experiences.

2.2 Oligopolistic markets and objectives of firms

Post-Keynesian firms operate in oligopolistic markets, where a few mega-corporations dominate smaller firms. The former are price setters: they make the prices, they aren’t forced to take them by the market. Smaller firms are price takers, having to follow the prices set by big companies. Prices are not set to clear markets and equalize supply and demand. For simplicity, we’ll assume firm owners and managers have the same goal: survival of the firm in the long run. This isn’t always the heterodox approach: Galbraith, for example, instead emphasizes the conflicts between them.

2.3: The Shape of Cost Curves

The post-Keynesian approach to costs collows the Leontief production function, in which there is a fixed quantity of labor and capital required to produce a good. These quantities are determined by technology. The neoclassical approach instead uses Cobb-Douglass functions, where labor and capital can be substituted for each other.

2.4 Price setting

“All post-Keynesian models rely on cost-plus pricing”, where a costing margin is added on top of some measure of cost to obtain the final price. Prices are administered: determined well in advance of products coming to market. There are 3 main models of administered pricing, each with a different method of determining the costs or markup.

2.5: The determinants of the costing margin

It may be hard to believe that firms freely change their prices when unit costs change. But it’s important to note that these pricing methods are based on costs in normal times. Firms prefer to absorb short term changes in costs by lowering the profit margin while keeping prices constant. This keeps buyers loyal: a surprise change in prices could mess with buyers’ plans.

2.6: Consequences for macro theory

The micro discussion above carries important implications for macroeconomics. For example, in post-Keynesian theory, an increase in aggregate demand generally does NOT lead to an increase in prices. Exceptions to this exist for raw materials and agriculture, which act more like the neoclassical model. In those cases, post-Keynesians support buffer stock programs to ensure higher prices don’t cause inflation elsewhere through higher costs. Also, higher demand does lead to higher prices at sustained full capacity: so, avoiding supply bottlenecks is key.

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