Sunday, April 20, 2014

Adam Smith on the Labour Theory of Value

There has been a lot of discussion of the labour theory of value in the comments section lately, a view which, I think, most Post Keynesians reject, and rightly so.

But Marx took the idea that labour is a measure of value and that labour is the cause of value from Ricardo (Robinson 1964: 36), and this idea in turn seems to stem from Adam Smith.

Adam Smith postulated that labour time was the criterion used in primitive societies to determine exchange value:
“In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. It is natural that what is usually the produce of two days’ or two hours’ labour, should be worth double of what is usually the produce of one day’s or one hour’s labour.

If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour’s labour in the one way may frequently exchange for that of two hours’ labour in the other.

Or if the one species of labour requires an uncommon degree of dexterity and ingenuity, the esteem which men have for such talents will naturally give a value to their produce, superior to what would be due to the time employed about it. Such talents can seldom be acquired but in consequence of long application, and the superior value of their produce may frequently be no more than a reasonable compensation for the time and labour which must be spent in acquiring them. In the advanced state of society, allowances of this kind, for superior hardship and superior skill, are commonly made in the wages of labour; and something of the same kind must probably have taken place in its earliest and rudest period.

In this state of things, the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity is the only circumstance which can regulate the quantity exchange for which it ought commonly to purchase, command, or exchange for.” (Smith 1845: 20).
But is there any hard empirical evidence from anthropology and history that this is true?

For example, since hunters usually have different levels of skill and experience, and often success in hunting depends on luck, the hunting time for any particular animal caught could vary considerably. It is simply unclear to me why hunter-gatherers or hunter-horticulturists would have to determine exchange value in such a way, when labour time could vary to a significant degree on each occasion an animal is hunted, and it looks like Adam Smith is engaged in some speculation here that would need to be backed up with a great deal of evidence from anthropology to be taken seriously.

Perhaps that evidence exists, but perhaps not too, like many hoary old myths in economics. I have not yet had a chance to look at the anthropological literature, and so will leave the question open.

Robinson, Joan. 1964. Economic Philosophy. Penguin, Harmondsworth.

Smith, Adam. 1845. An Inquiry Into the Nature and Causes of the Wealth of Nations, Thomas Nelson, Edinburgh.

Saturday, April 19, 2014

Mark-up Pricing in Italy

Fabiani, Gattulli and Sabbatini (2004) report the results of a survey on price setting behaviour by Italian firms (see also Fabiani, Gattulli and Sabbatini 2007).

The survey was conducted in January 2003 and involved 333 industrial and service firms (Fabiani et al. 2004: 8), although about 66% were industrial firms. Furthermore, the survey was biased towards firms selling producer goods or wholesale goods (Fabiani et al. 2004: 13).

It was found that about 60% of firms review prices once a year, and around 50% only actually change prices once a year too (Fabiani et al. 2004: 21).

Firms were asked how their unit variable costs change when there is an increase in the level of production, and the following results were obtained:
Increasing costs | 48.5%

Unchanged/flat costs | 21.3%

Decreasing costs | 27.2%

N.A. 2.5%.
(Fabiani et al. 2004: 14).
So 48.5% of firms reported flat or decreasing unit variable costs: roughly half of firms surveyed.

The firms were asked how they set the price of their main product, and the following answers were obtained:
Mark-up on unit variable costs | 63.1%

Regulated price | 13.3%

Other | 7.3%

No Answer | 16.3%.
(Fabiani et al. 2004: 16).
Mark-up pricing emerges as the overwhelmingly important type of price setting behaviour. It is also interesting here to see that regulated prices only account for only 13.3% of prices, which is far lower than the percentage for mark-up pricing.

As I have argued here, it is a mistake to think from survey data like this that firms are only using unit variable costs to calculate their mark-up price. On the contrary, when firms are pressed on this issue and we look at all the other empirical evidence, it emerges that most mark-up pricing firms are using total average unit costs (including fixed/overhead costs).

Firms were also asked to assess the importance of various theories explaining price rigidity and the theories were ranked as follows from most important to least important:
(1) Co-ordination failure

(2) Temporary shocks

(3) Explicit contracts

(4) Pricing thresholds

(5) Menu costs

(6) Bureaucratic reasons.
(Fabiani et al. 2004: 25).
These results are in line with other national surveys, but the failure to include cost-based as a theory was a major oversight.

Firms were also asked if a rise/fall in demand was an important factor in causing price changes, but some 51.1% of firms said demand changes were either unimportant (13%) or of minor importance (38.1%) in driving price changes (Fabiani et al. 2004: 26). Only 34% of firms said demand was an important factor.

Most firms reported that cost shocks were the most important factor driving price changes (Fabiani et al. 2004: 27).

Finally, price changes tend to be asymmetric: cost shocks are more likely to raise prices than reduce them (that is, firms often do not decrease prices if costs fall), and demand changes, to the extent they influence prices, tend to cause price decreases rather than price increases (that is, firms generally do not adjust prices upwards when demand increases but might reduce them if demand falls) (Fabiani et al. 2004: 34).

Fabiani, Silvia, Gattulli, Angela, and Roberto Sabbatini. 2004. “The Pricing Behaviour of Italian Firms: New Survey Evidence on Price Stickiness,” ECB Working Paper Series No. 333

Fabiani, Silvia, Gattulli, Angela, and Roberto Sabbatini. 2007. “The Pricing Behaviour of Italian Firms: New Survey Evidence on Price Stickiness,” in S. Fabiani, C. Suzanne Loupias, F. M. Monteiro Martins and Roberto Sabbatini (eds.), Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York. 110–123.