Michał Kalecki

Contributions to economics

Background and overview

Despite the fact that Kalecki authored many theoretical economic constructs, his interest in economics was more practical than academic and resulted from his work in engineering, journalism, credit investigation, use of statistics and observation of business operations. Full-time university teaching, for which he did not have formal qualifications (a degree), he did only during the last thirteen years of his career. He was contemptuous of abstract research and declined Keynes's invitation to undertake a critique of Jan Tinbergen's econometric business cycle work, for which he would also lack an in-depth knowledge of statistical theory.

Kalecki stressed that the predominant economic growth models were built on the assumption of an idealized laissez-faire capitalism and did not properly take into account the crucial and empirically demonstrable role of the government sector, the state's intervention and the interaction between the state and private sectors.

In 1943 Kalecki wrote: '... "discipline in the factories" and "political stability" are more appreciated by the business leaders than are profits. Their class instinct tells them that lasting full employment is unsound from their point of view and that unemployment is an integral part of the normal capitalist system.' The capitalists therefore want to limit government intervention and spending as disruptions to laissez-faire that reduce their "state of confidence" in the overall economic performance, with the notable exception of armament spending and policies that lead to increased armament spending (the last point Kalecki emphasized again in 1967).

The economics of Kalecki was based, more explicitly and systematically than that of Keynes, on the principle of the circular flow of income that goes back to the Physiocrat François Quesnay. According to that principle, income is determined by expenditure decisions, not by the exchange of resources (capital or labor). Kalecki and Keynes claimed that in capitalist economy, production and employment levels (economic equilibrium) are determined foremost by the magnitude of investment by business enterprises (the crucial "driver of the business cycle"), not by price and wage flexibility. Savings are determined by investments, not the other way around. Contrary to the Ricardian and Neoclassical economics, Kalecki asserted that higher wages lead to fuller employment. His monetary theory was rooted in the business cycle theory of Knut Wicksell. Quesnay's circular flow of income fell into disrepute in the political economy of the 19th century, when the idea that prices integrate exchange decisions gained ground, but was revived by Joseph Schumpeter, who pointed out the necessity of considering the circular flow of income (recognition of the economic cycle) as an integrating factor in order to gain a comprehensive understanding of the total economic process in a given period. The principle was discarded again with the arrival of neoliberal domination in economics and its main current defined by prices of economic equilibrium.^[b] Economist Jan Toporowski said that Kalecki's theory of the business cycle remains "the most serious challenge to general equilibrium macroeconomics", which has prevailed since the late 19th century. More than Keynes, Kalecki was skeptical about government's ability to sustain fiscal and monetary stimulus policies or of business support for full employment.

Like Keynes, Kalecki was concerned with demand management. Kalecki distinguished three ways of stimulating demand: through the government improving conditions for private investment (a time-consuming and burdensome for the populace process of which he was skeptical), through redistribution of income from profits to wages, and through public investment that increases employment and demand automatically.

Kalecki was engaged in the problems of developing countries. He argued that their industrialization depended on land reform and taxation of land owners and the middle classes. He was skeptical about a positive role of foreign direct investment in stimulating economic modernization. Polish economist Oskar Lange, who worked with Kalecki also on centrally planned socialist economies of the Soviet Bloc, characterized him as a "leftist Keynesian".

According to Toporowski, Kalecki's monetary theory is of particular significance. Unlike Keynes, Kalecki regarded credit as a fundamental system of financial reckoning in capitalist economy, not just as clearing of payments between commercial banks and a central bank. He saw monetary policy as endogenous to the business cycle, dependent on business investment rather than on interest rate and credit policy of central bankers. Unlike Keynes, who followed the partial equilibrium approach, for Kalecki economic dynamics was synonymous with the business cycle, where "the circular flow of income generates cumulative changes from one period to the next". Kalecki and Lange stressed the necessity of analysis of actually-functioning capitalism in both the advanced and developing countries, before economic theories could be built or courses of action prescribed. Kalecki's studies of capitalist enterprises included their finances, investment patterns and factors that influence investment, such as the development of financial markets, microeconomic conditions, and governmental fiscal interventions.

Profit equation

The volume of economic literature written by Kalecki during his life was very large. Although in most of his articles he returned to the same subjects (business cycles, determinants of investment, socialist planning), he often did it from a slightly unusual perspective and with original contributions.

Kalecki's most famous contribution is his profit equation. Kalecki, whose early influences came from Marxian economists, thought that the volume of profits and their sharing in a capitalist society were vital points to be treated. This followed from Karl Marx's work on relationships such as the rate of surplus value or the organic composition of capital (and even a forecast about the overall trend of profits). However, Marx was not able to make a meaningful statement about the total volume of profits in a given period.

Kalecki derived this relationship in an extremely concise, elegant and intuitive way. He starts by making simplifications which he later progressively eliminates. These assumptions are:

• Divide the whole economy into two groups: workers, who earn only wages, and capitalists, who earn only profits.
• Workers do not save.
• The economy is closed (there is no international trade) and there is no public sector.

With these assumptions Kalecki derives the following accounting identity:

${\displaystyle P+W=C_W+C_P+I}$

where ${\displaystyle P}$ is the volume of gross profits (profits plus depreciation), ${\displaystyle W}$ is the volume of total wages, ${\displaystyle C_P}$ is capitalists' consumption, ${\displaystyle C_W}$ is workers' consumption and ${\displaystyle I}$ is the gross investment that has been made in the economy. Since we have supposed workers who do not save (that is ${\displaystyle W=C_W}$ in the preceding equation), we can simplify the two terms and arrive at:

${\displaystyle P=C_P+I}$

This is the famous profits equation, which says that profits are equal to the sum of investment and capitalists' consumption.

At this point, Kalecki goes on to determine the causal link between the two sides of the equation: does capitalists' consumption and investment determine profits or profits instead determine capitalists' consumption and investment? Kalecki says,

"The answer to this question depends on which of these items is directly subject to the decisions of capitalists. Now, it is clear that capitalists may decide to consume and to invest more in a given period than in the preceding one, but they cannot decide to earn more. It is, therefore, their investment and consumption decisions which determine profits, and not vice versa".

For someone who has not seen the preceding relationship before, it might, upon examination, seem somewhat paradoxical. If the capitalists consume more, obviously the amount of funds which they have at the end of the year should be less. However, this reasoning, obvious to the individual entrepreneur, is not true for the business class as a whole, as the consumption of one capitalist becomes part of the profits of another. In a way, "they are masters of their fate".

If in the preceding equation we move capitalists' consumption to the left, the equation becomes:

${\displaystyle S=I}$

since profits minus capitalists' consumption are the total saving (${\displaystyle S}$) in the economy, because the workers do not save. The previous causal relationship still applies, and goes from investment to saving. That is to say, total savings are determined once investment has been determined. Therefore, in some way, investment generates sufficient resources. "Investment finances itself", so that equality between savings and investment is not caused by any interest rate mechanism as earlier economists thought. Finally, we can eliminate the assumptions of the original equation: the economy can be open, there may be a government sector and we can let workers save something. The resulting equation is:

${\displaystyle P_N=C_P+I+D_g+E_e-S_w}$

In this model total profits (net taxes this time) are the sum of capitalists' consumption, investment, public deficit, net external surplus (exports minus imports) minus workers' savings. Before trying to explain income distribution, Kalecki introduces some behavioural assumptions in his simplified equation of profits. For him, investment is determined by a combination of many factors difficult to explain, which are considered given, exogenous. Regarding capitalists' consumption, he considers that a simplified form is the following equation:

${\displaystyle C_P=A+q\cdot P}$

That is, capitalists' consumption depends on a fixed part (independent part), the term ${\displaystyle A}$, and a proportional share of profits, the term ${\displaystyle q}$, which is called the marginal propensity to consume of the capitalists. If this consumption function is substituted into the profit equation, we have:

${\displaystyle P=A+q\cdot P+I}$

Expressed in terms of ${\displaystyle P}$, this gives:

${\displaystyle P=\frac{A+I}{1-q}}$

The advantage of the above manipulation is that we have reduced the two earnings determinants (capitalists' consumption and investment) to only one (investment).

Income distribution and the constancy of the share of wages

Income distribution is the other pillar of Kalecki's efforts to build a business cycle theory. To do this, Kalecki assumes that industries compete in imperfectly competitive markets, more particularly in oligopolistic markets where firms set a mark-up on their variable average costs (raw materials, wages of employees on the shop floor that are supposed to be variable) in order to cover their overhead costs (salaries to senior management and administration), to obtain a certain amount of profit. The mark-up fixed by firms is higher or lower depending on the degree of monopoly, or the ease with which firms can raise price without causing reduction in the quantity demanded. This can be summarized in the following equation:

${\displaystyle P+B=k\cdot (W+M)}$

where ${\displaystyle P}$ and ${\displaystyle W}$ are profits and wages, ${\displaystyle k}$ is the average mark-up for the whole economy, ${\displaystyle M}$ is the cost of raw materials and ${\displaystyle B}$ is the total amount of salaries (which must be distinguished from wages, represented by variables, while salaries are considered fixed). The equation allows us to derive the wage share in the national income. If we add to both members ${\displaystyle W}$, and pass one to the other side, we have:

${\displaystyle Y=k\cdot (W+M)+W}$

If we multiply each side by ${\displaystyle W}$, and pass to the other term, we have:

${\displaystyle \alpha =\frac{W}{W+k\cdot (W+M)}}$

or:

${\displaystyle \alpha =\frac{1}{1+k\cdot (1+j)}}$

where ${\displaystyle \alpha }$ is the wage share in the national income and ${\displaystyle j}$ is the relation between the cost of raw materials and wages. It follows that the wage share in the national income depends negatively on mark-up and on the relationship of raw material costs to wages. At this point Kalecki's interest is in finding out what happens to the wage share during the business cycle. During recessions, firms collaborate among themselves to cope with the fall of profits, so the degree of monopoly increases and this increases the mark-up. The ${\displaystyle k}$ parameter goes up. Nonetheless, the lack of demand during recessions causes a fall in the price of raw materials, so the ${\displaystyle j}$ parameter goes down. The argument is symmetrical during the boom: prices of raw materials rise (${\displaystyle j}$ parameter increases) while the strength of unions due to increased employment level causes the degree of monopoly and thereby the mark-up level, to fall. The conclusion is that the α parameter is roughly constant over the business cycle.

Finally, we need an equation that determines the total product of an economy:

${\displaystyle 1-\alpha =\frac{P+B}{Y}}$

which is to say that the share of profits and salaries are the complement of the share of wages. Solving for ${\displaystyle Y}$ gives:

${\displaystyle Y=\frac{P+B}{1-\alpha }}$

Now we have the three components necessary to determine total product: an equation of profits, a theory of income distribution and an equation that links the product with profits and income distribution. It remains only to substitute the expression for ${\displaystyle P}$ which we obtained before:

${\displaystyle Y=\frac{\frac{I+A}{1-q}+B}{1-\alpha }}$

The preceding equation shows the determination of income in a closed system without public sector. It shows that output is completely determined by investment. How will output change from one period to the next? Insofar as we have assumed that ${\displaystyle A}$ and ${\displaystyle B}$ are constants, the above formula comes down to the multiplier:

${\displaystyle \mathrm{\Delta }Y=\frac{\mathrm{\Delta }I}{(1-q)\cdot (1-\alpha )}}$

The problem of the change in output and hence the business cycle is therefore due to changes in the volume of investment. It follows that it is in investment where we must find the reasons for the fluctuations of a capitalist economy.

Determinants of investment

The above argument demonstrates the crucial role played by investment in a capitalist system. Finding a well-specified investment function would facilitate resolution of many problems in the capitalist economy. This subject had been treated for an extended period by Kalecki, and he was never completely satisfied with his solutions. This is because the factors that determine investment decisions are multiple and not always clear. What follows is the solution Kalecki gave in one of his books.

Kalecki's investment function in the study of business cycles is the following:

${\displaystyle D=a\cdot S+b\cdot \frac{\mathrm{\Delta }P}{\mathrm{\Delta }t}-c\cdot \frac{\mathrm{\Delta }K}{\mathrm{\Delta }t}+d}$

where ${\displaystyle D}$ is the amount of investment decisions in fixed capital, ${\displaystyle a}$, ${\displaystyle b}$ and ${\displaystyle c}$ are parameters that specify a linear relation, ${\displaystyle d}$ is a constant which can vary in the long-run, ${\displaystyle P}$ are profits, ${\displaystyle S}$ is the gross saving generated by the firm, and ${\displaystyle K}$ is the stock of fixed capital. The equation shows that investment decisions depend positively on savings generated by the firm, the rate of change of profits, a constant which is subject to long-term changes, and negatively on the increase of fixed capital.

The above equation is able to generate cycles by itself. During booms, firms are able to generate more cash flow and enjoy increases in profits. However, the increase in orders for capital investment increases the stock of capital, until it becomes unprofitable to make more investments. Ultimately, the variations in the level of investment generate the business cycles. As Kalecki would say:

"The tragedy of investment is that it causes crisis because it is useful. Doubtless many people will consider this paradoxical. But it is not the theory which is paradoxical, but its subject – the capitalist economy."

Influence

In the first half of the 1990s, Oxford University Press published 7 volumes of Collected Works of Michal Kalecki, referring to him as "one of the most distinguished economists of the 20th century." Many of his works were translated into English for the first time in this collection.

Kalecki's work has inspired the Cambridge (UK) post-Keynesians, especially Joan Robinson, Nicholas Kaldor and Richard M. Goodwin, as well as the modern American post-Keynesian economists.