« Average and Recent Quarterly Real GDP Growth | Main | It's a Fish Eat Fish World »

Sunday, April 30, 2006

John Kenneth Galbraith's Contributions to Economics

This is from Stanley Brue's The Evolution of Economic Thought, 5th ed., Chapter 19, The Institutionalist School, pgs 407-412. It is a non-technical, easily readable description of some of Galbraith's main contributions to the field of economics:  

JOHN KENNETH GALBRAITH

John Kenneth Galbraith (1908-2006) was born in Canada and studied at the Universities of Toronto and California. His experience has included the post of chief economist for the American Farm Bureau Federation, high positions with the U.S. government during World War II, membership on the board of editors of Fortune magazine, ambassador to India during the Kennedy administration, professor of economics at Harvard University, and chairman of the Americans for Democratic Action. Galbraith is also a novelist and an expert on Far Eastern art.

Taken as a whole, Galbraith's major writings constitute both an attack on neoclassical economic thought and an analysis of modern capitalism. Nearly all of the characteristics of the institutionalist school apply to his many works.

The Conventional Wisdom

Galbraith is a critic of the neoclassical "conventional wisdom": a set of ideas that is familiar to all, widely accepted, but no longer relevant. His evolutionary approach explores changing conditions and examines the need to change our ideas to fit new situations. In a statement similar to that made by Veblen, Galbraith said, "Ideas are inherently conservative. They yield not to the attack of other ideas but to the massive onslaughts of circumstances with which they cannot contend." He is quick to point out that his attack is on the conventional wisdom, not on those who originally expounded the ideas:

The reader will soon discover that I think very little of certain of the central ideas of economics. But I do think a great deal of the men who originated these ideas. The shortcomings of economics are not original error but uncorrected obsolescence. The obsolescence has occurred because what is convenient has become sacrosanct.[16]

And how is it that these obsolete neoclassical ideas have been able to survive? Galbraith answers as follows:  

The neoclassical system owes much to tradition - it is not implausible as a description of a society that once existed....

Additionally it is the available doctrine. Students arrive; something must be taught; the neoclassical model exists. It has yet another strength. It lends itself to endless theoretical refinement. With increasing complexity goes an impression of increasing precision and accuracy. And with resolved perplexity goes an impression of understanding."[17]

Within Galbraith's overall theory of modern capitalism one can find several specific theories that challenge orthodox economics. Two theories of particular importance are his notion of the "dependence effect" and his theory of the behavior of the firm.  

The Dependence Effect

According to Galbraith, modern capitalism is dominated by large enterprises and characterized by an abundance of contrived wants that are the product of corporate planning and massive advertising:

As a society becomes increasingly affluent, wants are increasingly created by the process by which they are satisfied.... Wants thus come to depend on output. In technical terms, it can no longer be assumed that welfare is greater at an all-round higher level of production than at a lower one. It may be the same. The higher level of production has, merely, a higher level of want creation necessitating a higher level of want satisfaction. There will be frequent occasion to refer to the way wants depend on the process by which they are satisfied. It will be convenient to call it the Dependence Effect.[18]

It is not consumers who are sovereign in the modern industrial system, but rather the gigantic firms that produce and market goods and services. In Galbraith's "revised sequence," producers decide what shall be produced and then mold consumers' tastes so that they buy these products. Orthodox economics hold that initiative lies with the consumer, who buys goods and services in the market in response to personal desires or demands. The neoclassical theories of consumer choice takes wants as given. To say that consumers maximize their utility, says Galbraith, begs the important question of how consumers go about formulating those wants in the first place. And, if wants must be created through advertising, how urgent can they be? Furthermore, the neoclassical theory of consumer demand, with its emphasis on consumer sovereignty, implies that the market dictates the optimal composition of output and allocation of resources. This view, said Galbraith, makes little sense: "One cannot defend production as satisfying wants if that production creates the wants."

Galbraith's theory of consumer demand has an important policy implication: there will be an underallocation of resources to public goods. Galbraith called this circumstance "social imbalance." The creation of artificial wants through advertising and the propensity for emulation shifts resources toward private goods and away from public goods that have greater inherent value. New automobiles are seen as being more important than new roads; vacuum cleaners in the home are desired more than street cleaners. Alcohol, comic books, and mouthwashes take on a greater aggregate importance than schools, courts, and municipal swimming pools. One way to remedy this imbalance, said Galbraith, would be to impose sales taxes on consumer goods and services, using the proceeds to increase the availability of public sector goods and services.

Galbraith's Theory of the Firm

The neoclassical theory of the firm concludes that corporate behavior and performance can best be understood by assuming that firms attempt to maximize profits. According to Galbraith this may be true in the market sector, where owners of small firms actively manage their enterprises, but does not describe the far more important planning sector - the 2000 or so largest firms that produce over half of society's output. In the planning sector, ownership and control are divorced. The owners of the giant firms are the millions of holders of common stock who have no actual control over the operation of the corporation. Instead, control is exercised by the technostructure - a professional elite consisting of executives, managers, engineers, scientists, product planners, market researchers, marketing personnel, and so on. The disgruntled stockholder who does not like the performance of a particular firm does not have the option of firing the management. The usual recourse is to sell the shares of the company and to buy shares of another company. It is naive, said Galbraith, to assume that the technostructure has an incentive to maximize the return to the millions of anonymous stockholders. The technostructure pursues much more complex purposes, which he categorized as protective and affirmative.

The central protective purpose of the firm is survival, which translates into the need to earn a profit sufficient to keep most stockholders relatively happy and to provide sufficient retained earning for investment and growth. One way that this less-than-maximum profit can be assured is by taking product price out of competition. Doing this can take the form either of direct price fixing or of informal price understandings within an industry. It is not the purpose of price fixing to restrict output and maximize joint profits as the neoclassical model implies. Instead, the purpose is to assure that the rival firms earn a satisfactory level of profit, thus enabling them to meet their protective goals and to pursue their affirmative purposes.

The major affirmative purpose of the firm is corporate growth. Growth of output, sales, and revenues produce greater employment security and financial rewards to the members of the technostructure. In the orthodox theory of the firm, oligopolists restrict their production in order to boost their prices and enhance their profits: "No point is better accepted by the neoclassical model than that the monopoly price is higher and the output smaller than is socially ideal. The public is the victim. Because of such exploitation, oligopoly is wicked."[19] In Galbraith's theory, oligopolists fix prices at low levels - ones that achieve a minimum profit and permit expansion of total output and sales. Huge advertising outlays, campaigns to gain market share, unprofitable mergers between competitive and noncompetitive firms, and so forth, all make perfect sense if the goal is growth. According to Galbraith, "The neoclassical model describes an ill that does not exist [high oligopolistic prices and restricted output] because it assumes a purpose that is not pursued [profit maximization]. "[20]

Galbraith's theory of the firm has several interesting policy implications. For example, traditional antitrust efforts should be abandoned: "Nothing has yet happened to arrest the development and burgeoning power of the technostructure." Large firms have grown because of technological imperative. Their size owes to economies of scale, large research and development budgets, and the ability to incorporate new technology. It has been, and will continue to be, futile to try to arrest these forces through public policy, said Galbraith:

Thus the [antitrust] remedy that emerges from the neoclassical model is harmless. It presents no threat to the power or autonomy of the technostructure or to its affirmative interest in growth. And since the remedy is thought to be comprehensive - since competition is considered the remedy for all industrial ills - it directs all complaints into an essentially harmless channel. What might be dangerous agitation for effective regulatory action or for public ownership or socialism comes out safely as a demand that the antitrust laws be enforced.... Best of all from the standpoint of the technostructure would be immunity from all attack. But the next best thing - and a very good thing - is a system of ideas that diverts all attack into channels that are safely futile."[21]

Should society then simply pursue a policy of laissez-faire, counting on these economic forces to produce the social good? Galbraith answered with a resounding "No." In the preface of his Economics and the Public Purpose he stated, "On no conclusion is this book more clear: Left to themselves, economic forces do not work out for the best except perhaps, for the powerful."

Although exploitation of consumers is not a problem of modern capitalism, there are other grave problems that arise from the exercise of power by the planning system. The public, through government, must wrest control of the planning sector of the economy from the technostructure, ensuring that it serves the public purpose. This control should take several forms. For example, a permanent public price and wage agency should control the prices of the largest firms in the economy and ensure that wage gains in the major collective bargaining agreements do not exceed the growth of national productivity. A public planning authority needs to be established to join with the major corporations and unions to plan and coordinate economic activity. This planning authority will also have to coordinate economic plans with other industrial nations. Along with these reforms, Galbraith has called for government redistribution of income through public control of executive salaries, progressive taxation, an increase in the minimum age, and a negative income tax plan. Firms in the market sector should be encouraged to merge so that they can compete more effectively with the firms in the planning sector. Like Veblen and Mitchell before him, Galbraith sees the need for a greatly expanded role for government in the modern economy.

Criticisms

Galbraith's attack on conventional economics has produced many rejoinders. As just one example, critics have pointed out that, at the extreme, he seems to deny that the consumer has free will, that the buyer is able to determine his own interests and act on them. Orthodox economists reject this view and its implication that some undefined entity other than consumers themselves might best determine what is in the consumers' true interests. As another example, critics have stated that a firm that fails to maximize its long-run profits runs the danger of becoming a target for a corporate takeover. The price of the target firm's common stock, which reflects the discounted stream of its anticipated future earnings, will be lower for the nonprofit maximizer than it could be. By offering shareholders a price for their stock above the present market price, the acquiring firm can gain control of the target firm, replace the management, increase profits, and make a capital gain on their initial holdings.

In conclusion, Galbraith's volleys at economic orthodoxy, like those of Veblen before him, could be said to have forced neoclassicists temporarily to halt their march, to have required them to acknowledge and even engage the opposition. Galbraith elicited much return fire. This very fact - that he could not easily be ignored - is a testament to his powers of intellect, wit, and pen. Nevertheless, orthodox economics has experienced few casualties and even fewer defectors; put bluntly, it marches on. For institutionalism to reemerge as a major force in economic thought, it must win the minds of a future generation of economists. Its best hope for doing this is to develop a unified set of theories, readily understandable and teachable, that hold up to careful intellectual and statistical scrutiny. To date, say its detractors, it has not accomplished this.


[16] John Kenneth Galbraith, The Affluent Society (Boston, MA: Houghton Mifflin, 1958), 4.
[17] John Kenneth Galbraith, Economics and the Public Purpose (Boston, MA: Houghton Mifflin, 1973), 27.
[18] Galbraith, Affluent Society, 158.
[19] Galbraith, Economics, 119.
[20] Galbraith, Economics, 120.
[21] Galbraith, Economics, 121.

    Posted by on Sunday, April 30, 2006 at 10:54 AM in Economics | Permalink  TrackBack (1)  Comments (11)

          

    TrackBack

    TrackBack URL for this entry:
    http://www.typepad.com/services/trackback/6a00d83451b33869e200d8345d411e69e2

    Listed below are links to weblogs that reference John Kenneth Galbraith's Contributions to Economics:

    » Louis Rukeyser, My Mentor, My Memory © from Be-Think

    "Wall $treet Week, I watched when I had no money to speak of or invest, and no connection to the study of economics. I was a regular viewer even though, for years, the idea of understanding finances literally brought me to tears. Nevertheless, I love... [Read More]

    Tracked on Wednesday, May 03, 2006 at 08:33 PM


    Comments

    Feed You can follow this conversation by subscribing to the comment feed for this post.