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«NINA SHAPIRO Competition and aggregate demand Abstract: This paper examines the macroeconomic effects of competition. The Kaleckian view of these ...»

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Competition and aggregate demand

Abstract: This paper examines the macroeconomic effects of competition. The

Kaleckian view of these effects is considered along with the neoclassical, with

special attention paid to the degree of monopoly and its effect on investment.

Both the product and price competition of firms are examined, and the macroeconomics consequences of imperfect competition are shown to be quite different than the ones highlighted in economics.

Key words: aggregate demand, competition, macroeconomics.

Macroeconomic treatments of competition highlight its beneficence, finding in the competition of markets the mechanism that clears them. Wage or price “stickiness” explains unemployment in the macro models of neoclassical economics,1 and while price changes have no “real balance” effects in the Kaleckian models, price flexibility has its benefits here also. A proportionate fall in money wages and prices will not bring up employment, but a fall in prices relative to wages will.2 That shift of income to labor increases the propensity to consume, raising aggregate demand and the employment from investment. Employment and output levels are inversely related to the “degree of monopoly” (Kalecki, 1965), and investment dependent on the maintenance of competition (Steindl,

1976) and competitive price policies (Robinson, 1956).

The following takes up the question of the macroeconomic benefits of competition, considering the effects of competition, and different kinds of competition, on employment and investment. Product competition is considered along with price and cost competition, and imperfect compeThe author is Professor of Economics, Saint Peter’s College, Jersey City, New Jersey.

An earlier version of this paper was presented at the Joan Robinson Centennial Conference, held in Burlington, Vermont, October 2003. The author thanks the conference participants, along with Richard Garrett and David Levine, for their comments on the argument.

1 The “bastard” Keynesian models are reviewed in Robinson (1965) and the new Keynesian ones in Kregel (1996).

2 This is emphasized in Davidson’s discussion (2000) of the Kaleckian model.

Journal of Post Keynesian Economics / Spring 2005, Vol. 27, No. 3 541 © 2005 M.E. Sharpe, Inc.

0160–3477 / 2005 $9.50 + 0.00.


tition is shown to be more beneficent than the perfect competition idealized in economics.

Price flexibility The competition that clears Walrasian markets is a peculiar kind. There are no changes in the sales of firms or the revenues from products. Products are offered for sale at different prices, but none are sold at changing prices. Their prices are adjusted before they are supplied, with both their sale and production postponed until the equilibrium prices are realized.

“False trades” are not made, and no firms suffer losses.

But while the prices cried out by the Walrasian auctioneer can fluctuate without changing the revenues of firms, the prices firms receive for their products cannot. Changes in those prices occur in time rather than “on the blackboard” (Robinson, 1973). They cannot be lower without falling and cannot fall without lowering profit margins, and cuts in prices can wipe out profits. The price competition of firms can be “ruinous,” and it can be ruinous even if wages fall with prices, for labor costs are not the only costs of enterprises.

Firms have the expenses of their plant and equipment, and service charges on their debt, and those fixed costs cannot be reduced with prices.

Debt can be cut only through default, and capital equipment can be sold off only through the sale of the firm or at a loss. The capital costs of the firm are “sunk,” as are the product development costs; and because they are the same at all prices of the product, the competition of firms can drive prices below costs. Prices can be cut below the “full” costs of products, minimizing the losses of firms rather than maximizing the profit; for as long as prices stay above the average variable costs of production, firms are better off selling products at a loss than not selling them at all.

Competition can reduce profit margins too much, bringing them below the level needed for the recoupment of costs. And while a ruinous competition lowers prices also, and real wages may come up with the fall in prices, the lower prices and higher real incomes come at the expense of firm bankruptcies and losses. Rentiers and the employed will be able to increase their expenditures, but the firms that suffer losses will have to reduce theirs. They will have to cut costs to remain in operation, and the job cuts of the firms will bring down employment, as will the bankruptcies and industry consolidations undertaken to stem the losses. And while the ruinous competition will not destroy all the firms of the industry, it will deplete the finances and consume the energies of all. None of the firms will have much money to invest in their products,


or time for the consideration of investment projects, and falling prices and uncertain sales are not propitious conditions for investment.

The competition will disrupt the industry investment as well as reduce the employment, and with employment and investment falling in the industry, and prices competed down, wages will not stay up. Firms will press for wage concessions, and job cuts and the threat of more will force their acceptance. And while the fall in the industry prices will increase the purchasing power of consumers, the fall in wages and employment will not. It will reduce aggregate demand, as will the disruption of the industry investment, and instead of stimulating the economy, the competition of the industry could bring on a downturn, with the fall in the wage bill of the industry decreasing the sales of other industries, and the fall in their sales pressing prices down and thus reducing their wages and employment. A ruinous competition could become a “ruinous” deflation.

Deflationary “spirals” are possible also, and a wage-price deflation is as “injurious” as inflation (Keynes, 1971, p. 36). And not only can wages be brought down through a fall in prices, price competition can be fought through wage reductions. Cost advantages over competitors can be gained through the payment of lower wages, for, contrary to what is assumed in economics, the firms of an industry need not pay the same wages. They can be located in different regions or have different labor practices, and when costs can be reduced through the employment of cheaper labor, wages will be competed down with prices. Firms will have to reduce wages to remain competitive, and wages will fall as firms match the wage cuts of competitors, and the lowest-paying firms increase their market share.3 Competition can displace high-paying firms as well as inefficient ones, and the low-paying firms of an industry need not be less efficient than the others. They can employ the same equipment and technology and have as productive a workforce. The cost differences of firms can be rooted in wage as well as productivity differences, and the competitive energies of firms can be directed toward the cheapening of their labor rather than the improvement of their products and production processes.

Perfect competition Whereas ruinous competition is associated in economics with oligopoly, it can occur in perfectly competitive industries, and, indeed, a ruinous 3 It should be noted here that a fall in wages will reduce real wages even if prices fall proportionally, as workers also have “fixed costs” (e.g., debt payments, rent, and insurance).


competition is more likely under the conditions of perfect competition than it is under those of oligopoly.4 The competition of an industry depends on the similarity of its products. The more similar the products, the greater will be the competitive pressure on prices, and the products of a perfectly competitive industry are homogeneous. The sales of firms depend on prices only, and the prices of competitors have to be met for any sales to be kept. Firms have no loyal clientele to hold up sales when prices are undercut, and they cannot “fix” prices either. There is no dominant firm to enforce price agreements, and it makes little sense for firms to honor them when new competitors can undercut prices. A perfectly competitive industry is too open for price-fixing arrangements (Eichner, 1969)—it does not have the entry barriers of oligopoly.

Perfectly competitive firms can neither protect prices through product differentiation nor hold them up through price collusion, and as they have the same costs as well as the same products, none of the firms can win out in a price war.5 None will be able to charge less than the others, for all will make the same profit at the same prices. The price cuts that cut the profit of competitors will reduce their own, and the prices that ruin any of the firms will ruin them all. Price wars will continue as long as the firms can withstand them, and any shortfall in sales will set them off, as firms match each other’s price cuts. Their competition will not only “flex” prices, it will depress them; and while perfectly competitive firms are small, and their productive capacity limited, they too have fixed costs that do not change with prices.

Perfectly competitive firms have equipment investments also, and, indeed, their products could not be homogeneous if they were not produced by machinery (ibid.).6 And while the debt of those firms may be less than that of large, oligopolistic concerns, their debt burden can be as great, or even greater. The profit margins of small enterprises are too slim for the internal financing of investment, and their reserves too small to weather revenue shortfalls. They will borrow more than larger, more 4 Although the conditions of perfect competition are well known, their results are not, as only the equilibrium ones are discussed in the microtexts.

5 The importance of cost differences in the competition of firms is emphasized in Steindl (1976).

6 Only machines can produce products of uniform quality and design, human beings and nature cannot. Hand-crafted products have the mark of the artisans that created them, whereas the properties of agricultural products depend on the time and place of their production, and even those grown at the same location (such as apples on an apple tree) will vary in quality and shape.


secure concerns, and pay higher interest rates. The small firms that comprise a perfectly competitive industry are the most heavily leveraged enterprises (Steindl, 1945), and the necessity of servicing their debt, and recouping costs, will lock them into ruinous price wars.

The perfect competition idealized in economics is far from ideal. It indebts firms and bankrupts them, and its ruinous competitions bring down investment. They are contractionary as well as destructive, and they impede investment as well as disrupt it, for when product revenues are precarious, long-run expectations cannot be positive. Firms cannot expect to make a profit on a product long enough to recoup the costs of plant and equipment or product development. Those long-term investments are not profitable when firms have no control over prices, and the price competition of a perfectly competitive industry would deter investment, as would the excess capacity.

New competitors bring new productive capacity into an industry, and there will be many new competitors in a perfectly competitive industry.

Firms would enter the industry whenever profits rose, and any number could enter when they rose. The “swarming” of new entrants in times of rising sales and profit will shoot up the productive capacity of the industry, reducing its utilization and cutting the profit from it. Firm entry worsens the excess capacity problems of industries, and the “fear” of excess capacity would itself deter investment under the entry conditions of perfect competition (Richardson, 1990).

Profit margins might be lower under perfect competition than under oligopoly, and the employment from investment higher, but investment will be lower also. Investment depends on competitive conditions too, and the lower profit margins of perfect competition come at the cost of economic growth and stability.

Oligopoly The entry barriers of industries hold down their excess capacity and hold up their prices. They make industries safe enough for investment, and although they also lessen competition, they do not end it. Oligopolists compete also—they are capitalist enterprises too, with the same desire for accumulation as any other.7 They want to expand their markets and 7 “The great firms are far from restricting output—they are continuously expanding capacity, conquering new markets, producing new commodities, and exploiting new techniques.... Modern industry is a system not so much of monopolistic competition as of competitive monopolies” (Robinson, 1971, p. 103).


increase their market dominance, and their product competition can be as beneficial as the price competition of less protected enterprises. Indeed, it can be more beneficial, for product competition increases the investment in products.8 The product changes that update and differentiate the products of firms require equipment changes and, in some cases, the installation of new production lines, and the advertisement that publicizes the differences in products is an investment in them also. Firms that compete on the basis of their products must improve them as well as advertise them.

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