A Theory of Consumption and Speculation to Round Out Sraffa’s Theory of Production

by Philip Pilkington

Article of the Week from Fixing the Economists

Recently I discussed the fundamental differences between the Sraffian and the marginalist systems. Since then I was perusing Sraffa’s Production of Commodities By Means of Commodities (full PDF available here).

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It’s a very nice piece of work. Tightly argued, elegantly written and quite illuminating in many respects. It is also completely free of nonsense; the argument makes no outlandish assumptions about how humans behave or firms operate or anything of the sort. Now, as I said in the original piece: Sraffa’s is just a narrative framework for broadly conceptualising how the economy kind-of-sort-of functions. Those who draw direct inferences from the work about the really existing economy are seriously misguided; or, put more clearly: you cannot apply Sraffian models to reality.

I have been thinking, however, what the main objection to Sraffa’s work might be. It seemed to me obvious that there are three potential objections. The first — and most obvious — is outlined by the Austrian economist Bob Murphy in a post with the silly title Sraffa’s Production of Fallacies by Means of Fallacies.

Why do I call the title ‘silly’? Because Murphy doesn’t actually note any fallacies in Sraffa’s argument (hint: on its own terms, there are none). Indeed, the word ‘fallacy’ does not appear in the body of the text at all and no actual fallacies are noted. (I should say that in order to get a good basic overview of Sraffa’s argument Murphy’s post is not a terrible place to start).

Anyway, the actual issue that Murphy raises is the most obvious one and, I believe, was the one raised by the mainstream economists in the 1960s. He writes,

Despite his interesting approach and clever results, Sraffa does not succeed in overthrowing marginal value theory. Rather than replacing the modern focus on subjective decisions made on the margin, Sraffa simply assumes them away. For example, in the simplest case of a subsistence economy, Sraffa just takes it for granted that the people in this economy will continue to produce 400 quarters of wheat and 20 tons of iron every period, forever. But why should they do this? Suppose the people don’t like iron or wheat! Or, more to the point, suppose the people discover a better use for their stocks of iron and wheat than to simply make more iron and wheat. How are the people supposed to break out of their subsistence mode in Sraffa’s world?

What is the answer to this question? It is rather simple: Sraffa’s is not a theory of consumption, rather it is a pure theory of production. One of the key problems with the marginalist argument is that they try to make their theories of production and consumption almost identical in form and content. But there is no real-world justification for this; in reality the two spheres are separate and should be theorised separately.

So, how might we conceptualise consumption to take place in the Sraffian system? Actually, I think this is pretty simple. In order to do so we turn to some variant of Old Institutionalist theory — I think in particular, for example, of the work of John Kenneth Galbraith. Here’s a schema for how we conceive the consumption side of the economy in this regard.

Basically, firms set their prices in line with the Post-Keynesian theory of the mark-up. The equilibrium in the productive sector comes about by the fact that inputs are a cost and so these are transferred directly into the pricing mechanism through the mark-up pricing mechanism. The amount of the ‘surplus’, as Sraffian theory calls it, is also arrived at by the firm’s chosen mark-up. We need not, as Sraffa assumed, think that over some time period the surplus is equally distributed across firms. Rather we should just assume that a firm cannot generally gouge too much profit without consumers switching to a cheaper competitor.

But this still leaves Murphy’s question unanswered. How do the firms know when to sell different products without market demand signals that transmit information through price? Simple. As the Old Institutionalists knew well, they do this through surveys and market research. This is how things work in the real-world. Firms come up with new potential products and then they engage in extensive market research. If the market research shows that the new product will be popular they produce it; if the market research shows that there will likely be no appetite for the product it is not produced. This is precisely how things work in the real world and it allows for innovation without any need for marginalist-style price-signals.

The second potential criticism that may be put to Sraffa’s framework is more difficult but not, I think, unresolvable. It is basically this: through the use of marketing firms can actually raise prices on products that are otherwise identical. If we take two pairs of running shoes that have identical inputs but one of which is made by a firm that convinces a sports celebrity to wear them in public, that firm can charge a higher price for their shoes.

We can integrate this, however, if we go back to what we discussed above; namely, the idea that the surplus is not evenly distributed across firms. Some firms will always figure out how to get disproportionate amounts of the surplus and clever marketing techniques are one way of doing this. While it is tempting to view this as a sort of monopoly I think this is misleading — indeed, to even discuss monopoly in Sraffa’s system seems to me misleading. Rather we should see such actions as the Old Institutionalists did: as innovations that rest upon persuasion and power.

Note that this interpretation of Sraffa’s system means that we cannot allow for it to be an endorsement of the hoary old labour theory of value. In this interpretation value is subjective in two ways. First, because people have a substantial input into what they ‘value’ in the form of market research. And second, because there is an element of persuasion in the marketplace which gives rise to people valuing identical products for their purely symbolic attributes. (I have written about this latter aspect in more detail here).

Finally, there is the third objection. This objection, I think, is by far the most serious and it is this one that my own work seeks to address. This objection is basically as follows: prices can actually be subject to speculative pressures. In Sraffian language: if a person uses their share of the (monetised) surplus to bid up the price of a given commodity by buying it and hoarding it in order to increase their monetised surplus by reselling it at what they hope to be a higher price then price dynamics can be driven in this manner too.

This is more damaging to the Sraffian theory because Sraffa is very careful to try to evade questions of supply and demand in his work. But these simply cannot be avoided if we take into account the dimension of speculative price dynamics. Thus while Sraffa’s theory can provide the “base” of a general theory of economic production, an Old Institutionalist theory of consumption must be grafted on as a sort of “superstructure” together with a theory of speculative price-dynamics. I have, of course, been endeavoring to create such a theory of speculative pricing. And while the theory is by no means complete, the underlying structure is very much so in place.

Again, however, we must stress that the attempt to interpret Sraffa’s theory as being a labour theory of value theory becomes impossible. With a speculative component value becomes subject to the beliefs of investors/speculators facing an uncertain future. A piece of land or a house, for example, become worth simply what people think them to be worth at any given point in time.

As we can see, if we join Sraffa’s theory of production with the Old Institutionalist theory of consumption together with my own theory (still a work in progress) of speculative price-formation we get a far more realistic narrative about how the actual economy functions than we do in the old marginalist story. Yes, marginalist economists may object to this narrative because it disagrees with their own. But unless they can come up with compelling evidence that, for example, firms respond more so to price signals than to market research findings when opening up new product lines, or that speculative price-dynamics are unimportant to the functioning of capitalist economies, then they will only be arguing through recourse to pure self-assertion. But then, I suspect that this is precisely what they have been doing since the late-19th century.