Budget constraints and business enterprise: a Veblenian analysis.

Author:Wilson, Matthew C.
 
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"It takes money to make money" as Poor Richard might say. Business opportunities multiply as the capital at hand increases, whereas they dwindle to little or nothing when capital is relatively insubstantial. While this aphorism, qualified in one way or another, sustains wide credence perhaps even among economists, it is not always recognized that it stands in conflict with the normative ground of property rights under the canons of classical thought. In the classical tradition, the productivity of real resources (in classical theory: labor; in neoclassical theory: land, labor, and capital) is the normal ground, both actual and legitimate, of the ownership of wealth and receipt of income. Thus productivity is the "normal basis" for the consumer's budget constraint.

The premise that "it takes money to make money" upsets this classical postulate, because it implies that the strategic use of money assets is a means to acquire more money assets, in which case money has real causal force, both in the acquisition' of income and in the control of productive enterprise. That being the case, one could not hope to reduce the sources of individual wealth to expenditures of productive force.

The paper shows that the Veblenian critique can be used as the basis for a critique of the neoclassical treatment of budget constraints. It is argued that the structure of neoclassical producer and consumer theory sustains this underlying canon of classical thought. The latent influence of this canon can be seen in the asymmetrical treatment of budget constraints. The neoclassical consumer faces a budget constraint, which, it is strongly suggested, is somehow derived from the productivity of his land, labor, and capital. However, the neoclassical producer faces no comparable budget constraint on his productive enterprise.

I am using the phrase "budget constraint" here as analogous to the consumer's budget constraint, which is an amount of money assets that the consumer has before the purchase of output, which constraints the purchase of that output. A comparable budget constraint on the firm would be an amount of money assets that the firm has before the sale of output, which constrains the production of that output.

It can be seen that the neoclassical firm does not face a budget constraint in this sense. Rather it is constrained only by the amount of money it receives from the sale of output. In the supply and demand diagram, time is absent. Read literally, this implies that the receipt of sale proceeds is simultaneous with the remuneration of marginal costs incurred. This treatment obviates any role that a budget constraint, or more generally a financing constraint, might play: at the level of the firm, production is self financing.

In this context, if the firm maximizes profits, its production is constrained to be on the optimal isoquant. The producer then faces a series of isocost lines but not a budget constraint. The only long-run constraint on the scale of output achieved by the individual producer is that the firm must minimize long-run average total cost.

If this were not the case, i.e. if the producer faced a budget constraint, then, even in the long run, the scale of output would depend upon pecuniary constraints stemming from the producer's financing sources. In effect, it would "take money to make money," and, from the standpoint of economic theory, the classical canon of the legitimate basis of income and wealth would be vitiated. That is, capital income received would depend not upon productive forces expended but rather upon perspicuous, shrewd or just plain lucky capital investment.

In contrast with neoclassical producer theory, where the firm faces no budget constraint (and thus is unconstrained by its prior accumulation of money and capitalized assets), the paper argues that the more general concept of a financing constraint on business enterprise is essential for an explanation of the evolution of a firm's productive capacity, particularly when the firm faces constant returns to scale. The constraint is made up of internal and external financing sources, which, as Veblen points out, are linked together by the value of collateral.

Preliminary Remarks on Veblenian and Post-Keynesian Theory

In the analysis that follows, readers who are acquainted with the post-Keynesian tradition will recognize that many of the doctrines discussed are, in one form or another, already widely regarded as pillars of post- Keynesian thought. In fact, some readers might have the impression that either nothing original is being said or that due credit is not being given for doctrines that are rightly credited to Keynes and the post-Keynesians.

To state the obvious, however, Veblen's work antecedes Keynes's General Theory and long antecedes the subsequent rise of the post-Keynesian movement. This point naturally leads to the following question: Why do post-Keynesians rarely cite Veblen?

For instance, consider three founding leaders of the post-Keynesian movement: Paul Davidson, Alfred Eichner and Hyman Minsky. Seminal works such as Davidson (1972) and Minsky (1986) make no mention of Veblen, and Eichner (1976) mentions Veblen only in passing. Elsewhere, Eichner (1983) acknowledges that Veblen's theory of conspicuous consumption is useful for post-Keynesian analysis, but he does not seem to credit Veblen with other contributions judged to be equally relevant to post-Keynesian theory.

While Veblen's contribution to business cycle theory has been neglected in seminal post-Keynesian literature, ironically it also seems to have been under-appreciated by institutionalists. Only a few observers, institutionalist or otherwise, seem to have recognized how Veblen's theory of business enterprise foreshadows key elements of the Keynesian revolution (Vining 1939; Raines and Leathers 1996; Hodgson 2004).

The neglect, both by post-Keynesians and institutionalists, of Veblen's prior development of key post-Keynesian themes is notable. For instance, Vining (1939) argues that Veblen should be counted as one in a line of theorists, including Hobson, who anticipated Keynes' theory of effective demand. He also sees Veblen as having maintained a monetary conception of interest rates. Raines and Leathers (1996) note Veblen's theory of stock market cycles, which is based on instincts, habits of thought, and folk psychology. They see this theory as complementing and strengthening Keynes' concept of speculative stock markets. They also note that Veblen was one of the first major theorists to connect speculative movements in securities prices to the financing of the modern corporation, thereby connecting both to the business cycle (138).

Beyond this, as I argue below, Veblen can be credited with, among other things, the arguments that: the classical and neoclassical traditions leave no meaningful role for money or monetary institutions; that production is concatenated (i.e., involves what today are called input-output matrices), so that production processes take time; that the distribution of income cannot be reduced to productivity; that the classical theory of distribution (and thus Say's law) will not hold, because in general, future demand is unknown; and that credit finance constrains investment and the scale of output, due to the role of collateral and thus retained profit.

Beyond this, the paper argues that Veblen developed a clear sense in which the classical tradition falsely generalizes a special case credit institution, and he provided the conceptual basis for a general theory of a credit-based market economy. He also anticipated Robinson's critique of neoclassical capital theory and Kalecki's principle of increasing risk. Each of these arguments is usually credited to Keynes and the post-Keynesians.

The Veblenian Critique and Its Bearing on the Standard Concept of a Budget Constraint

In a famous series of essays, Veblen (1898a; 1899a; 1899b; 1900; etc.) described the classical (and neoclassical) tradition as resting upon ontological preconceptions that are pre-Darwinian in character. These preconceptions are rooted in the spiritual standpoint of the early political economists. Contemporary economists may not wittingly endorse these pre-Darwinian views. Yet, according to Veblen, those preconceptions nevertheless remain latent within economic doctrines handed down from the past.

Under the preconceptions of the classical economists, the economy is regarded as a "natural system" or "providential order." The invisible hand of the market then is literally the hand of God, which operates through the natural system that God designed. This natural system is characterized by, among other things, a "law of the conservation of economic energy" (Veblen 1898a, 377; 1901, 192). Under this conservation principle, economic energy expended is conserved as economic income received. The classical conception of the legitimate basis of property rights is then intimately connected with this conservation principle:

... the law of economic equivalence, or conservation of economic energy, was, in early economics, backed by [a] second corollary of the order of nature, the closely related postulate of natural rights. The classical doctrine of distribution rests on both of these, and it is consequently not only a doctrine of what must normally take place as regards the course of life of society at large, but it also formulates what ought of right to take place as regards the remuneration for work and the distribution of wealth among men. (Veblen 1901, 194) In this classical scheme, money has no important role. If money enters the picture at all, it enters in commodity form, as the nth commodity, which lubricates "the great wheel of circulation" (Veblen 1898a, 382). "Money is ... discussed in terms of the end which, 'in the normal case,' it should work according to the given writer's ideal of economic life, rather than in terms of causal relation" (383). For instance...

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