Alternative PK microeconomic foundations

The firm: Objectives and constraints

Realistic features

• The modern firm operates in oligopolistic industries.

• Oligopolies are dominated by megacorps, i.e., Galbraith's technostructure, usually of the M-type, with multidivisional structures.

• Unit costs are NOT U-shaped.

• Cost-plus pricing is a pervasive phenomenon.

• Prices set by firms in the short run are not market-clearing prices, i.e., prices are not such that they equate demand to supply.

Different approaches to pricing and markets

AuthorPost-Keynesian Theory Neoclassical Theory

Kalecki (1971) Cost-determined pricesFinished and industrial

goods

Demand-determined pricesRaw materials, agriculture

Means (1936) Inflexible prices Flexible prices

Administered prices Market-clearing prices

Sawyer (1995) Firm-determined prices Market-determined prices

Long-term strategic prices Short-term prices

Okun (1981) Price maker Price taker

Price-tag markets Auction-market prices

Hicks (1974) Fix-price markets Flex-price markets

Chandler (1977) Visible hand of management

Invisible hand of markets

Sraffians Reproducible goods Non-reproducible goods

Power through growth

• "The basic goal of those in charge of the firm is to cause sales revenue to grow as rapidly as possible.... But I do not agree with Marris that this pattern of behaviour is caused by the separation of ownership from control. Instead, I believe it to reflect the fact that (in so far as the two conflict) the urge for power is stronger than the urge for money. As a result, growth maximisation is a phenomenon which is to be observed in (all except the smallest) unincorporated firms and in closely owned companies as well as in large quoted companies with widely dispersed ownership" [Wood 1975 p.8].

Kalecki’s principle of increasing risk

• «...The expansion of the firm depends on its accumulation of capital out of current profits. This will enable the firm to undertake new investments without encountering the obstacles of the limited capital markets or `increasing risk'. Not only can saving out of current profits be directly invested in the business, but this increase in the firm's capital will make it possible to contract new loans » [Kalecki 1971].

• "Finance raised externally -- whether in the form of loans or of equity capital -- is complementary to, not a substitute for, retained earnings'(Kaldor 1978).

Managerial capitalism vs finance capitalism

• Managerial capitalism is sometimes said to be over.

• However, there has always been a finance constraint on firms.

• Managers still rule: they set their salaries and they defraud small shareholders.

• But profitability is now more likely to be obtained by pressuring down costs (wage costs) instead of raising prices.

What is managerial capitalism? Main authors

• Berle and Means 1933

• Galbraith 1967 The Industrial State

• Marris 1964

• Chandler 1977

• (Veblen 1899, 1904) Absentee Ownership

What is managerial capitalism?

• There has arisen a new class, the managers, who are neither owners nor ordinary workers They are the white collars : managers, but also engineers,

• They constitute the Technostructure, a going concern (collective will), (cadrisme)

• They have strong ties with the firm: tradition, working rules, dividend policy, etc.

• Long-run survival, permanence, long-term objectives• Large institutional shareholders are passive, and rarely

attempt to modify the behaviour of management

What is financial capitalism ?

• More hostile take-overs• Target rates of return on equity (ROE), often set at 15%• Share value maximization• Pay schemes to encourage managers to achieve the goals of

high stock market prices and high ROE• Managers have no loyalty to fellow workers or their clients:

their only loyalty ought to be to the owners – the shareholders.• Part of the old Technostructure is deprived of its former

participation; core management at headquarters takes over: high remuneration and even fraud.

• Short-terminism: short-term goals take precedence over long-term goals since many of today’s owners will not be owners in the future.

1/(1+)i

G

R

Growth rate

Profit rate

Expansion Frontier

Finance Frontier

g

r

The constraints on growth

The expansion frontier• The expansion frontier relates the maximum profit rate firms can

hope to reach for each growth rate. These frontiers must be thought of as constraints operating on firms and their long-term prospects. It has a bell shape.

• The growth of an institution can carry both positive and negative effects. When rates of growth are weak, positive effects outweigh the negative effects. When firms invest a lot, they are better able to integrate the latest technologies and therefore reduce their costs of production and increase their profit rate.

• However, with ever faster growth, it becomes more difficult to familiarize employees with the philosophy and the management techniques of the firm. This is the Penrose effect (1959).

• Moreover, rapid growth often implies diversifying towards less familiar lines of products, engaging into important marketing expenses, or reducing profit margins. All of these are bound to reduce the maximum attainable profit rate, thus explaining the downward-sloping part of the expansion frontier.

The finance frontier

• The finance frontier (Marris, 1971; Sylos Labini, 1971) defines the minimum profit rate, r, that a firm must get in order to grow at g, when the average interest and dividend rate are equal to i.

• The finance frontier explains the internal and external financing opportunities of the firm. Investment can be financed internally (self-financed) or externally, through debt, by either borrowing from banks or turning to financial markets by issuing shares. We assume borrowed funds are a multiple, ρ, of retained earnings.

1/(1+)i

G

R

Growth rate

Profit rate

Expansion Frontier

Finance Frontier

gg

r

r = i + g /(1+)

I = (P – iK)+ (P – iK) retained earnings + new loans

The constraints on growth

gr

Alternative formulation

• I + f.I = sf(P + ifF– idD)+ (P + ifF– idD) + x.I

• I + f.I - x.I = sf(P + ifF– idD)+ (P + ifF– idD)

• (1+ f – x) I/M = (sf + )(P + ifF– idD)/M

• (1+ f – x) g = (sf + ){r + (ifF– idD)/M}

• f = proportion of financial investment• x = proportion of share issues• M = stock of tangible capital (machines)

Managerial vs finance capitalism

• “Among the manifestations of this lack of control over management were the pursuit of market share and growth at the expense of profitability” (OCDE 1998, in Stockhammer 2003).

1/(1+)i

G

R

Growth rate

Profit rate

Expansion Frontier

Finance Frontier

g

r

r = i + g /(1+)

The constraints on growth: Impact of higher interest rates or dividend rate

i’

1/(1+)i

G

R

Growth rate

Profit rate

Expansion Frontier

Finance Frontier

g

r

r = i + g /(1+)

The constraints on growth: Impact of weaker labour unions

i’

R’

g’

What has happened to the new capitalism? Financialization

• With their excess profits, firms purchase financial assets, i.e., they purchase the shares of other firms and they lend to households

• Excess profits are taken over by managers, whose income skyrockets

Managerial income has gone up

Consequences of financialization

• Financialization has not given more control to small shareholders.

• Managers earn more: payment schemes yield huge bonuses and separation pays.

• New payment schemes have induced managers to defraud their own companies or to report fake profits

• In some way, managerial control at the top is greater than ever.

Financialization and growth

• According to Stockhammer (2003), financialization has led to a situation of slower growth, which was only temporarily hidden by the stock market boom of the late 1990s that drove fast consumption.

1/(1+)i

G

R

Growth rate

Profit rate

Expansion Frontier

Finance Frontier

g

r

The constraints on growth

Utility function of managers with financialization

U