Last update: 8th Sept 2018

Lecture 5
Objectives of lecture
 The lecture seeks to the price and quantity of factor inputs into production from a
HETERODOX perspective.
 It seeks to show that the incomes accruing to factors, and the quantity of them
used in production, depends on relative power relations (between labour and
capital, and between productive/industrial and financial capital) and the
quantity of factor inputs depends on the level of profits.

Contents of lecture
General
 Heterodox economists deny that entrepreneurship is a factor of production.
Entrepreneurs are owners of firms that hire factors in the process of producing
goods.
 The Heterodox economists deny that there are factor markets as such, although
it is accepted that one can conceive of the demand for and supply of labour and
land.
 Heterodox economists see the price of factors as the return (or incomes
accruing) to these factors for a given period of time. Typically Heterodox
economists see these returns in money and not real terms.
 Heterodox economists deny that the magnitudes of these incomes are determined
in factor markets, by the supply of and demand for these factors in these markets.
o Profits, wages and rent are determined in the process of production.
o Interest is determined by central banks.

Capital
 The logic of heterodox analyses suggest the explanation of the returns to factors
should begin with profit as the return to capital owned by entrepreneurs.
 Heterodox economists deny there is such a thing as a capital market – a market
for material inputs, or the money to buy these inputs, which yield a profit.
 For Heterodox economists capital is best defined as a sum of money used to buy
all inputs into production which results in a profit in relation to the money outlays
which is appropriated by the owner of this money and the production process
which it is used to undertake.
 Heterodox economists typically make a distinction between types of capital;
between productive and financial capital. Productive capital refers to capital in
the productive process; whether it assumes the form of money or physical long-
lasting inputs. It is the capital of the entrepreneur. Financial capital refers to
capital in the financial sector which is lent to, and borrowed by, the productive
capitalist. It typically only assumes a money form.
 Heterodox economists define capital in the productive system as the money
advanced which is used to purchase all inputs into production, including labour
services.
 A corresponding distinction is drawn between profit and interest. Profit is the
return to those involved in production (industrial capitalists). It is seen as a
reward for risk. Interest is the return to those who lend money (i.e., the
financial capitalists) to the firms involved in the production of goods and
non-financial services (i.e., the productive capitalists) and others (e.g.,
consumers). It is seen as a reward for parting with money (as potential capital).
 The source of profit (and therefore also interest) is seen the productive efforts of
labour; whereby labour produces goods of a greater value than is paid to them in
terms of their wages (and other input costs).
 The magnitude of profit will depend on the institutional environment and the
extent to which labour can be disciplined by capital. For a given institutional
setting changes in the magnitude of profit depend on changes in output and the
productivity of labour. The total amount of profits appropriated by firms rises as
output rises and the productivity of labour rises. The more firms can produce and
sell the more total profit they make. The more they can use the existing amount of
labour to produce the expanded output, without paying labour more for the
expansion, the greater the profit they can obtain. Much of the increase in
productivity of labour is, because of this, due to the advance of technology.
 The rate of profit is the ratio of the money value of profit to the money value of
the capital advanced. It is seen as having a tendency to fall periodically due to the
rise in investment outlays.
 When talking of the demand for capital or investment demand, Heterodox
economists typically refer to demand for productive capital. That is to say it is a
demand to purchase inputs into production – including labour.
 This demand is argued to be dependent on past, current and expected
profitability, with the latter dependent to some extent on the former (past and
current profitability). Expected profitability is not, however, mechanically related
to past and current profits. It varies depending on the optimism of producers –
hence the tendency for investment to overshoot periodically due to excessive
optimism.
 To the extent that investment demand by the individual firm is seen as a function
of actual profits and the latter is related to the demand for the products of the
firm, aggregate investment demand can be seen as being fundamentally linked to
the final aggregate demand for all products. For Heterodox economists, this
demand is not a function of the marginal physical productivity of the productive
assets, even if one could ascertain what this is.
 The supply of capital is seen as the finance required to buy the requisite
productive assets. The source of this finance is seen to be for the most part the
retained earnings or actual profits of companies and not the savings of
individuals resulting from choices they are alleged to make between present and
future consumption. Heterodox economists argue that little of the finance
required to buy long-lasting physical inputs into production comes from outside
the company.
o In developing countries an additional source of financing is the state;
either bank credit or the state budget.
 Heterodox economists argue that, if anything, savings (investment finance) are (is)
inversely related to the (real) interest rate since it, interest, represents a deduction
from profits. That is to say, the higher the rate of interest the lower the rate of
profit.

Equilibrium
 Heterodox economists deny that there is any variable which can be argued to
bring the demand for and supply of capital into equality such that the two are in
equilibrium. Above all, they deny that the interest rate, even the real interest rate,
brings into equality the demand for and supply of capital.
 Following from this, Heterodox economists deny that a deficiency of capital can
be rectified by an increase in the real interest rate. In fact such an increase will
worsen the problem of a deficiency.
 Heterodox economists argue that typically changes in expected profits based on
changes in actual profits trigger an increase in investment and savings (the finance
available for investment). This process continues and eventually a discrepancy
arises between expected profits and actual profits (with expected profits
continuing to rise while actual profits start to fall). The investment-profits gap
begins to be filled by financial markets - credit. Eventually it is recognised that
expected profits are not going to materialise and those extending credit ask for
their loans to be repaid. This causes a collapse in investment by the producers as
they try and cut back on expenditures to meet their financial obligations. The fall
in investment gives rise to a further fall in actual profits thereby reinforcing the
pessimism among business investors.
 The whole process is continuously in motion and never at rest – never in
equilibrium.

Labour
 Heterodox economists too agree that what is bought and sold in the labour market
are labour services.
 They argue that the return to labour is the money wage and not the real wage.
 In Heterodox labour market analyses the supply of labour is seen as given for any
agreed real wage level. Workers bargain with employers for a certain money
wage and then employers put up prices to cover any increase in money wages they
may have to concede. The extent to which businesses can transfer increases in
money wages fully to prices will depend crucially on the degree of competition in
the particular industry and the overall state of the economy.
 It is assumed that there is always unemployed labour which can be utilised at the
given (real) wage rate. This means the labour supply curve is typically flat up to
the full employment level. Unemployment is important to keep labour under
control and prevent unions and labour organisations from bargaining for excessive
wage increases.
 The supply of labour can increase over time because of population growth and
institutional factors such as changes in welfare, laws concerning the participation
of women, etc.
 There is no agreed Heterodox view regarding the demand for labour. Most
Heterodox economists deny that the level of real wages and productivity have
much of a bearing on the demand for labour. They point instead to the
 importance of profits and investment by firms. As profits rise businesses expand
investments, which also means increasing their demand for labour. Some
Heterodox economists, following Keynes, see this demand as determined by the
real wage in the same manner as Neoclassical economists and using the same
rationale - the diminishing marginal revenue product of labour. However,
although they accept that this suggests a fall in the real wage could in principle
increase the demand for labour, they follow Keynes in arguing that the fall in real
wages would also most likely damage the demand for the products of labour and
thereby could have an overall negative impact on the demand for labour.

Equilibrium
 Heterodox economists deny that changes in the real wage bring into equality the
demand for and supply of labour. Rather, they argue that changes in investment
and the demand for the products of labour explain changes in the quantity of
labour employed in production. That is to say, there is no such thing as
equilibrium in the labour market, and certainly not so-called full-employment
equilibrium. For Heterodox economists unemployment is a necessary feature of
capitalism – the mechanism required to discipline labour and moderate wage
increases.
o Heterodox economists see credit based consumerism as an added and
increasing manner in which labour is disciplined.
 Heterodox economists also deny the notion of substitutability of labour for
capital, if the returns to one are in excess of market clearing levels. Heterodox
economists in fact believe in fixed relations of inputs; increases in the demand for
one factor are typically accompanied by increases in the demand for other factors.

Income distribution
 Heterodox economists explain incomes shares at the general level in terms of
power relations.
 They explain wage differences within industries in terms of a) the relative power
of different companies – allowing them to earn more profits some of which can be
paid out to the workers, b) institutional factors such as discrimination between
workers due to gender, colour, etc., c) regional variations, etc.
 They explain wage differences between industries in terms of a) profit
differences between them, b) differences in strength of labour organisation in the
different industries, and c) institutional factors which encourage salary differences
for functional reasons (e.g., the high salaries accruing to lawyers, accountants, etc
– in this case differences between occupation).
 They explain profit differences within an industry by a) differences in the
technologies used by different companies, b) the nature of product differentiation
in the sector, and c) marketing, etc.
 They explain profit differences between industries by a) relative monopoly
strength of producers in different industries (enabling higher degrees of mark-up),
b) institutional factors, and c) government support, etc.
 Heterodox economists see income shares (profit vs wages) as being determined
by institutional factors, including power relations between labour and capital,
and not productivity and individual choice.
 Heterodox economists see profits and wages as moving inversely to one another,
i.e., an increase in wages can cause a fall in business profit margins where
businesses are not able to recover the increase in price increases. This is
especially true if workers are able to index link wage increases.