Alfred Eichner - The Foundations of the Corporate Economy

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The Micro Foundations of the Corporate EconomyAuthor(s): Alfred S. EichnerSource: Managerial and Decision Economics, Vol. 4, No. 3, Corporate Strategy (Sep., 1983), pp.136-152Published by: Wiley

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h e i c r o oundations o t h e

orporate Economy

ALFRED S. EICHNERProfessor of Economics, Rutgers University, New Brunswick, New Jersey, USA

This paper challenges the orthodox microeconomic theory of the firm which is being gradually replaced as theconsensus view by managerialist, behaviourist, institutionalist and post-Keynesian schools of thought. Fromthis new microeconomics is emerging a synthesis which is providing the foundations for a theory of the'megacorp'. Megacorps have behaviour patterns at odds with those of the atomistic firm. Unless this isunderstood and an

appropriate theory developed, attemptsto

managethe

economy bytraditional means are

doomed to failure. The paper lays the foundations of such a theory at both the micro and macro levels.

Corporate planners and other business economistshave long been aware that the orthodox theory haslittle relevance to the type of environment in whichtheir companies are forced to operate. What theygenerally do not realize is that there now exists analternative body of theory-one which, though noless comprehensive and no less coherent, corres-ponds far more closely to what can be observed inthe real world of corporate enterprise. This alterna-tive body of theory, which represents a synthesis ofcertain ideas to be found within the managerial,'behavioralist,2 institutionalist3 and post-Keynesianliterature,4 can be termed the 'new microecono-mics', The purpose of this review is to explain whatis encompassed by that term.

The new microenomomics is intended, first andforemost, to provide a more useful model of firmand industry behavior. Instead of viewing the firmas merely the cat's paw of an impersonal market, it

regardsthe business enterprise, especially when it

takes the form of a modern corporation, ormegacorp, as an important source of independentdecision-making within the economy. The relevantset of decisions includes not just how much toproduce and what price to charge, as the orthodoxtheory would have it. It also includes how much toinvest and how to finance that investment. Indeed,the decision of how much to invest is far moreimportant to the firm's continued success than thedecision of how much to produce, with the decisionof what price to charge being more closely tied tothe former than the latter. The new microecono-mics, however, is also intended to provide a moreappropriate foundation for macroeconomic analy-sis. The output, price, investment and financedecisions made at the firm level are critical indetermining the macrodynamic behavior of thesystem as a whole, and if that macrodynamic

behavior, as represented by the growth of outputand employment as well as by the rise in theaverage price level, is to be adequately explained, itis necessary that the macro model rest on a solidmicro foundation.

In the sections which follow, the essentialfeatures of what can be termed the 'corporateeconomy' will first be described, along with those ofits representative firm, the megacorp. This is aneconomy consisting of industries which are pre-dominantly oligopolistic in structure, with a result-ing ability to maintain over time a certain margin,or mark-up, above costs. After the essentialfeatures of this corporate economy have beenspecified, a model of mutually determined invest-ment, prices, external finance and output will bepresented as the distiguishing centerpiece of the'new microeconomics'. This micro foundation ofthe corporate economy will then be compared withthe orthodox theory of the firm. The corporateeconomy is next modeled, at the macro level, to seewhat light can be shed on the secular inflation whichhas bedeviled advanced market economics like thatof the United States throughout the post-WorldWar II period. The exercise is carried out first inthe absence of uncertainty and thus with a con-tinuous, constant rate of expansion assumed; andthen, in a more realistic version of the same model,with allowance for three types of unforeseeableevents-major product innovation, inter-firm com-petition and a change in government policies.

THE CORPORATE ECONOMY AND THEMEGACORP

The corporate economy consists of k industries, as asubset of the n industries which comprise the

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enterprise sector, or production system, as a whole.These k industries sell their output either to eachother or to a group of proprietary firms which areengaged in retail distribution; and they buy theirinputs either from each other or from a secondgroup of proprietary firms engaged in agricultureand other types of primary production. The kindustries thus constitute a sub-matrix within thelarger input-output system, with the industriesrepresented by primary producers, retail distribu-tors and other non-corporate enterprises (e.g.residential construction firms) completing the sys-tem (Eichner, 1983; Pasinetti, 1981).

Not all of the k industries produce goods andservices for final consumption. Some, in fact,specialize in the production of the capital goodsused by the other industries to replace and expandtheir capacity over time. Indeed, it can be assumedthat for each industry producing a good or service

for final consumption (either by households or bythe government) there are one or more otherindustries supplying that industry, in turn, withcapital goods. (The same industry may, of course,supply capital goods to more than one otherindustry). Other industries specialize in producingmaterial inputs, such as refined metals and chemic-als. The industries producing this intermediateoutput, capital goods as well as direct materialinputs, represent the difference between the kindustries which comprise the corporate economyand the h industries producing items for final

consumption.Whatever the type of good it produces, each of

the k industries is oligopolistic in structure, with thefour leading firms supplying 75 per cent or more ofthe industry's output and with any new firms whichmight wish to enter the industry facing significantcost and other barriers. One of the four leadingfirms has a larger share of the market than theothers. It is the dominant firm and the industryprice leader (Shepherd, 1970; Blair, 1972). Like atleast one of the other leading firms, the price leaderis a large corporation, or megacorp (Eichner,1976), with the following characteristics.

(1) The megacorp is an organization rather thanan individual. This affects both the megacorp'sgoals and the way it makes decisions.

As an organization, the megacorp's goal is toexpand at the highest rate possible, measured bythe growth of cash flow or some correlate. It isexpansion at the highest rate possible that createsthe maximum opportunities for advancement withinthe organization, and thus the greatest personalrewards for those who are part of the firm'decision-making structure. To expand at the highestrate possible, the megacorp follows two rules: (a) itattempts to retain its present share of the market inthe industries to which it already belongs - as longas those industries are expanding at the same rateas the economy or better, and (b) it periodicallyexpands into newer, more rapidly growing indus-

tries while withdrawing from those in which thegrowth of sales has come to a halt and/or the profitmargin has been squeezed below the firm's targetrate of return.

The megacorp, as an organization, makes deci-sions through a managerial hierarchy. At the top ofthis decision-making, or internal political, structureis the executive group, which consists of the chiefexecutive officer and a number of senior vice-presidents (Gordon, 1945). It is the executive groupwhich makes the key decisions. These include: (a)the target rate of return on investment; (b) theinvestment projects to be included in the annualcapital budget; (c) the required mark-up; (d) theannual increment in wages and salaries and (e) anychange in the amount of external debt. Theexecutive group also determines which, if any, newindustries or markets the megacorp will attempt toenter and who, from among the middle manage-

ment, will succeed the present members of thegroup. In making these decisions, the executivegroup is constrained only by the laws of thecountries in which it operates and by the possibleloss of control to some outside group if the growthof dividends falls below a certain rate or if otherfinancial performance criteria (such as repayingloans as they come due) are not met (Wood, 1975).

(2) The megacorp operates not one but severalplants in each of the industries to which it belongs,with each plant embodying in the form of a fixed setof technical coefficients the least-cost technology

available at the time the plant was constructed (orlast modernized). The multiple plants it operateshave a significant bearing on the megacorp's costs,both as it varies output over the cycle and as itexpands capacity over the longer period.

In varying its output over the cycle, the megacorpwill either start up or shut down an entireproduction line, and in this way produce only at theleast-cost point which has been incorporated intoeach plant's design. A production line consists of allthe equipment needed, along with workers, toproduce a particular good or service. The amountof labor hours, together with the quantities of rawmaterials, needed to keep that production linegoing is, in turn, what the associated set of technicalcoefficients represents. Usually, to reduce theoverhead expense, a plant will consist of more thanone production line. Still, with each of thoseproduction lines being a duplicate of the others, thesame set of technical coefficients applies to theplant as a whole.

By either starting up or shutting down an entireproduction line (or plant segment) at a time, themegacorp is able to vary its output over the cyclewithout incurring any significant increase in itsaverage variable, and hence marginal costs. Thus itcan be assumed that the firm is subject to constantreturns over the short period represented by thetypical business cycle. The constant returns arepredicated, however, on (a) the megacorp having a

MANAGERIAL ND DECISION CONOMICS, OL. 4, NO. 3, 1983 137




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certain amount of reserve capacity, consisting ofplants with vintage equipment and hence somewhathigher operating costs,5 and (b) the megacorp usingits finished goods inventory to bridge the gapbetween current sales and current output. Themegacorp's reserve capacity, which is likely to beabout 25 per cent of total capacity in the case of adurable goods industry and about 20 per cent ofcapacity in the case of any other type of industry, iswhat enables the megacorp to vary its output overthe cycle by either starting up or shutting down anentire plant or plant segment. This reserve capacityenables the megacorp to handle any likely fluctua-tion in industry sales; thus it eliminates theopportunity for new firms to enter the industrybecause of unsatisfied demand. Changes in themegacorp's finished goods inventory, meanwhile,enable it to avoid any problem because of thediscrepancy between current sales and current

output. The amount of finished goods inventory issimply allowed to increase when sales are below theoutput of the production lines currently in opera-tion, and it is allowed to fall when sales exceed thatquantity of output (prior to an additional plantsegment being activated).

Over the long run, extending beyond any onecycle, the megacorp can be expected to add to itscapacity so as to keep pace with the secular growthof industry sales. This is essential if the megacorp isnot to lose market share over time. The new plantsbeing added will, to the extent product innovation

is occurring simultaneously in the capital goodssector, enable the firm to gradually reduce itslabor-output ratio within that industry (as mea-sured by its labor technical coefficients). This willcertainly be the case if, as can be assumed, the costof labor (measured by the money wage rate) hasbeen rising relative to the cost of other inputs andthe new plants therefore embody the latest labor-saving technology. Whether the firm's actual costsof production will also be declining will depend onwhich is rising more rapidly - money wages oroutput per worker (the latter measured by the rateof decline of the labor technical coefficients andhence, the firm's labor-output ratio). All that canbe said with certainty is that, with new plants beingadded that embody the latest technology, the firm'scosts will be less than they would otherwise be - andless when production is concentrated in the newerplants than when, because of an unusually highlevel of demand, the firm's reserve capacity has tobe utilized. Thus it can be assumed that theexpansion of capacity over time will be accompa-nied by a fall in the firm's labor-output ratio and,to the extent this is true of all firms within the kindustries which comprise the corporate economy,by a secular rise in output per worker. The effect onthe firm's unit costs of production will depend onthe growth of money wages relative to output perworker.

(3) The megacorp is a price setter (or price

matcher) rather than a price taker. This means thatthe prices in each of the k industries are seller-rather than market-determined, with those pricesestablished by adding a certain mark-up, or margin,to the unit costs of production.

The set of list prices announced in advance of anysales by the dominant firm, or price leader, andthen adopted as their own by the other leadingfirms will remain unchanged until the end of thecurrent pricing period (typically a year in the caseof durable goods industries, and six months in thecase of other industries).6 Those list prices will thenbe adjusted, depending on what has happened inthe interim to the unit costs of production as aresult of the growth of money wages relative tooutput per worker. Thus, in the short period, themark-up, if not the price level itself, can be viewedas being fixed. While prices may change, dependingon what is happening to the unit costs of produc-

tion, the same mark-up will be applied to thosechanging unit costs in order to arrive at the newprice list. What this means is that, in the shortperiod, the mark-up (and hence the set of listprices, to the extent those list prices are based onthe mark-up) is indeterminant. Within that timeframe, the mark-up is simply as given.

Over the longer period, however, the mark-up isvariable and indeed can be explained by thedominant firm's need for additional investmentfunds relative to the implicit cost of obtaining thoseadditional funds by increasing the mark-up. The

dominant firm can be expected to seek a highermark-up when (a) the need for investment funds toexpand capacity within the industry in line with thegrowth of sales (or to purchase new plant andequipment for some similarly essential purpose)exceeds the amount of cash flow being generated atthe existing mark-up, and (b) the cost of increasingthe mark-up, in terms of the long-term loss ofindustry sales due to the substitution effect, thegreater likelihood of attracting new firms into theindustry based on the entry factor and the risk ofretaliatory action by the government, is not exces-sive. Indeed, the cost of the additional internallygenerated funds, taking into account these lastthree factors, must be less than the cost of obtainingthe same funds through an increase in the firm'sexternal debt. Otherwise, the megacorp will find itmore advantageous to tap the capital funds market.The mark-up established within the industry in thelong period will be the one which balances off theexpected returns from investment against the costof obtaining the needed funds either internally froma change in the mark-up or externally by sellingnew securities (see below).

(4) The megacorp competes against other firmsthrough the various types of investment it under-takes rather than on the basis of price. This makesthe capital budget, followed by the advertising andR & D budgets, the critical means by which themegacorp improves its long-term position, both

138 MANAGERIAL ND DECISIONECONOMICS, OL. 4, NO. 3, 1983




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within individual industries and throughout theeconomy as a whole.

Investment projects are routinely screened forincludion within the capital budget by comparingthe prospective rate of return with the megacorp'starget rate of return. The target rate of return willdepend on the rate at which the megacorp hopes togrow over time. Indeed, the firm's desired growthrate, adjusted to take into account any corporateprofits tax, is the target rate of return. Thus, if themegacorp has the goal of expanding by 15 per centeach year and the corporate profits tax rate is 50 percent, the target rate of return will necessarily haveto be 30 per cent. Any project with a prospectiverate of return less than that figure will, even if allexpectations are subsequently realized, precludethe megacorp from achieving its growth objectives.Because it is more easily calculated, the inverse ofthe payback period is likely to be used to

approximate the prospective rate of return from agiven project. Thus the prospective rate of returnfrom a project that will enable the megacorp torecover any and all outlays within three years isapproximately 33 per cent. While, in chossingamong projects, it might seem necessary to takeinto account what returns are likely to be realizedbeyond the payback period, those returns can belargely discounted because, being so distant, theyare so uncertain. Restricting the projects to beincluded within the capital budget to those with acertain minimum payback period means that the

megacorp is less vulnerable to an unforeseeable,and thus uncertain, future (see Blatt, 1983, Ch. 12).There are two types of exceptions to the general

rule that projects will be included within the capitalbudget only if their prospective rate of return, asapproximated by the inverse of the payback period,equals or exceeds the megacorp's target rate ofreturn. One type of exception is a project which,unless included, will jeopardize the megacorp'smarket position within an industry. The expansionof capacity in line with the growth of industry salesfalls within this category. Since retention of itsmarket share in the industries in which it expects toremain over time is a necessary condition formaximizing the growth of the firm, this type ofproject is likely to be given the highest prioritywithin the capital budget. Indeed, it makes littlesense event to attempt to calculate the prospectiverate of return on such a project. Instead, thegoverning consideration is likely to be whether thefirm wishes to continue including that industryamong those to which it allocates its investmentfunds. The second type of exception to the generalrule that projects will be included in the capitalbudget only if their prospective rate of returnexceeds the target rate of return is a project whichinvolves expansion into an entirely new industry orline of business. Although in this case an attemptwill be made to calculate the payback period,

strategic considerations may be sufficiently impor-tant that they will, in fact, dictate the decision.These strategic considerations include the need toneutralize a similar move by a rival firm, the desireto tie up certain sources of supply or avenues ofdistribution and the importance of becoming famil-iar with a new technology.

(5) The megacorp's investment, pricing, com-pensation and finance decisions are part of anintegrated, sequential decision-making processwhich the executive group routinely carries outeach year (Vickers, 1968). This means that no oneof these decisions can be understood in isolation byitself. Each is complementary to the other, theentire set of decisions being the means by which themegacorp is able to maximize its growth over time.

The most important of these decisions, the onethat shapes the rest of the decision-making process,is what investment projects are to be included

within the capital budget. Still, before a capitalbudget can be developed, a financial analysis willhave to be carried out, with an estimate made ofthe cash flow likely to be generated, under currentsales projections, throughout the period covered bythe capital budget. It is this cash flow estimatewhich provides a first indication of what is likely tobe the increase, if any, in the capital budget. If, asmay well be the case, the number of projectsoriginating from within the organization which canmeet the target rate of return and/or other criteriaexceeds the cash flow likely to be generated during

the year, the executive group will need to decidehow to close the gap by (a) increasing the averagemark-up within one or more industries, (b) arrang-ing for external financing or (c) eliminating orstretching out certain projects. The first option tobe weighed will be an increase in the averagemark-up within one or more industries. However,any decision to try to increase the mark-up willhave to be part of a more comprehensive review ofpricing policy.

A MODEL FOR THE 'NEWMICROECONOMICS'

The situation in which the megacorp's executivegroup is likely to find itself upon reviewing thecurrent set of list prices within a given industry canbe represented by the following diagrams (Eichner,1976):

Its cost curves will be those shown in Fig. 1.Because of the multiple plants it operates, themegacorp is able to vary output with averagevariable, and hence marginal, costs remaining nearlyconstant up to 100 per cent of engineer-ratedcapacity (ERC). Given its deliberately maintainedreserve capacity, the megacorp will seldom operatein excess of 90 to 95 percent of capacity, so that





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pi

MC20 1ACF ~~~~~AVGAFC

AVC

60 80 100 ERC

Figure 1

only the interval between 65 and 95 per cent ofengineer-rated capacity represents the relevantrange of these cost curves. The megacorp's totalcosts, which include average fixed or overheadexpenses as well as the direct cost of labor andmaterials, will meanwhile decline steadily as outputincreases, this because of the greater volume overwhich they can be spread.

The list prices for the various goods, or productline, supplied by the industry can be expected tohave been set, during the previous price review, sothat on the average they cover the industry's totalcosts at the standard, or expected, rate of outputplus a certain rate of cash flow (ACF) or margin, M.This is shown in Fig. 1 by the price line, P0. (Thestandard rate of output is the level of output thatwould be needed to supply the market in theabsence of any cyclical fluctuations in sales. It isassumed, in Fig. 1, to be 80 per cent of engineer-rated capacity, thus implying 25 per cent reservecapacity as in the case of a durable goods industry.)The question facing the executive group, as itreviews the current set of list prices, is whether totry to effect a shift in this price line. While themegacorp will be in a better position to effect sucha shift it is the industry price leader, it can stillexpect to have some influence even if it is only oneof the firms which matches the set of list pricesannounced by the price leader. Through public

statements and similar means, it can at least makeits preferences known to the price leader; and theprice leader, to the extent it cannot act unilaterally,will have to take those preferences into account.

The first consideration, in trying to decidewhether there should be a shift in the price line, PO,is whether there has been an increase in the cost ofproduction since the last price review. It can beassumed that, at the very least, the firms in theindustry will attempt to offset any rise in costs by anupward shift in the price line, this to preserve theexisting mark-ups. Whether the costs of production

have been rising will, in turn, depend on what hasbeen happneing to (a) unit labor costs and (b) unitraw material costs. Any rise in unit labor costs willreflect the growth in money wages relative to thegrowth in output per worker while any rise in unitraw material costs will reflect the industry's position

within the input-output matrix and/or supply-and-demand conditions within world commodity mar-kets. The factors determining the past rise in unitlabor costs and unit raw material costs will then beprojected into the future to provide an estimate ofwhat increase in the average list price will benecessary to offset the expected increase in thecosts of production over the period until the nextprice review.

Once the expected increase in the unit costs ofproduction has been estimated, the next considera-tion is what change, if any, in the average mark-up,m, would be optimal. (The mark-up, m, is simplythe margin, ,u, divided by 1 - M. It is added to theaverage costs of production, C, to obtain the listprice and thus, unlike the margin, does not requirethat the list price already be known.) The optimalchange in the mark-up will depend on the demandfor additional investment funds (so as to be able tofinance a capital budget in excess of the cash flowbeing generated at the existing margin) relative tothe supply cost of those funds, whether the fundsare obtained internally or externally. That is,Am = f(DI, SI) where Am is the optimal change inthe mark-up; DI is a demand curve for additionalinvestment funds, based on the inverse relationshipbetween the expected rate of return, r, and theamount of additional investment funds employed,AF; and SI is the supply curve for additionalinvestment funds, based on the opposite, or, directrelationship between the implicit cost of anyadditional funds,

R,and the amount of those funds

to be obtained, AF.The implicit cost of any additional funds that

might be generated internally through an increasein the mark-up will depend on three sets of factors:(1) what has already been termed the substitutioneffect, that is, the reduction in the growth ofindustry sales over time as determined by the priceelasticity of demand, e; (2) the entry factor, that is,the possible loss of market share to new firmsattracted into the industry, as determined both bythe minimal size firm likely to enter the industry, q,

and the probability of new entry, r, associated witha given increase in the mark-up; and (3) thepossible untoward consequences of retaliatory ac-tion by the government as the mark-up is increased,as determined by the probability of governmentintervention, p. These three types of costs incurredby the megacorp, should it decide to increase thesize of the average mark-up, can be converted intothe equivalent of an implicit interest rate, R, by firstapplying the appropriate discount formulas (Eich-ner, 1976, Ch. 3) and then comparing the subse-quent decline in cash flow with the more immediate

gain in cash flow, the latter being the equivalent ofan externally borrowed principal sum for each yearthere is a net gain.

An increase in the mark-up, Am, is likely to leadto an increase in the average amount of cash flowgenerated per unit of output sold, A\ACF/C. This

140 MANAGERIAL ND DECISION CONOMICS, OL. 4, NO. 3, 1983




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relationship is depicted in quadrant (b) of Fig. 2.The average cash flow being generated increases,relationship is depicted in quadrant(b) of Fig. 2.The average cash flow being generated increasesbut at a decreasing rate, as the mark-up is increasedbecause both the substitution effect and the entryfactor can be expected to be greater the larger theincrease in the size of the mark-up. Meanwhile, theimplicit interest rate on these internally generatedfunds R, will also increase as the mark-up rises.This relationship is depicted in quadrant (d) of Fig.2. In the latter case the substitution effect and theentry factor cause the implicit interest rate toincrease at an increasing rate. Indeed, beyond acertain point, say mx, the probability of new entryinto the industry or of retaliatory governmentaction may be greater than the firm is willing torisk, establishing an upward limit on the possibleincrease in the mark-up. The two separate rela-

tionships depicted in quadrants (b) and (d) of Fig. 2together determine the shape of the firm's supplycurve for internally generated investment funds, SI,as shown in quadrant (a) of Fig. 3. This supplycurve is derived by first taking the values forAACFIt and R associated with each change in thesize of the mark-up, Am, and then scaling up thislocus of all common points as could be shown inquadrant (a) of Fig. 2, by a factor equal to thefirm's expected level of sales (its total engineer-rated capacity, ERC, multiplied by its standardoperating rate, SOR). In this way the average cash

flow generated shown on the right-hand axis of Fig.2 becomes the total cash flow, or additionalinvestment funds, AFIt, shown on the right-handaxis of Fig. 3.

The supply curve for internally generated funds,derived in this manner, can then be compared withthe demand curve for investment funds, based onthe expected rate of return on the various projectsconsidered for inclusion in the capital budget. Theportion of the demand curve shown in Fig. 3 is, infact, the portion represented by the projects whichcannot be financed from the flow likely to be

generated at the present mark-up. While anincrease in the mark-up would, in this case, seem to

(d) I? (a)

Am A m AACF/C

450 Am A~cF/c\ (b)

Figure 2

(d) I1 (a)

DIAm AF//

(c) A m (b)

Figure 3

make sense, the executive group would first need totake into account the firm's cost of external financebefore making a decision.

The firm's cost of external finance, i, is aweighted average (based on the firm's optimaldebt-equity ratio) of the interest it would have topay on any new fixed-interest securities (bonds) andthe inverse of the estimated price-dividend ratio atthe time it would be likely to sell additionalcommon shares. Both estimates would have to beadjusted to take into account (a) brokerage andother placement costs, and (b) the increased threatto the executive group's control from issuing newsecurities. This cost of external finance will thendetermine the shape of the firm's total supply curvefor investment funds - those obtained from the saleof new securities as well as those generatedinternally by an increase in the mark-up. Such acurve, SI, is shown in Fig. 4, with the portionextending from the origin to AFb coinciding withthe firm's supply curve for internally generatedfunds and the remaining portion coinciding with thesupply curve for external finance. The latter isassumed, in Fig. 4, to have a positive slope, but ifthe firm is a relatively small factor in the capital

R,r I

/1

AFb AF/f

Figure 4





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price leader and matched by the other firms in theindustry. This new list price, as shown in Fig. 8, willthen determine the vertical position of the indus-try's perfectly elastic supply-offer curve, P1. Thesupply-offer curve is perfectly elastic because, atthe average list price P1, each firm within theindustry is prepared to supply any quantity deman-ded. Indeed, it is the quantity then demanded atthat price from each firm which will determine thesales volume for the industry as a whole until thenext price review, and it is this sales volume towhich each firm's output decision will be geared.Since the latter involves only the question whichplants or plant segments to operate while using thefirm's finished goods inventory to make up thedifference, it is a decision likely to be made at alevel below that of the executive group. Still, itcompletes the process by which the level ofinvestment as represented by the size of the capital

budget, the rates of compensation and hence unitcosts, the average mark-up and thus a set of listprices, and the amount of external borrowing aremutually and sequentially determined over thecourse of a year. These decisions made at the microlevel by the megacorp are then the basis for thebehavior of the corporate economy which can beobserved at the macro level.

THE CORPORATE ECONOMYCOMPARED WITH THE ORTHODOXTHEORY OF THE FIRM

Before developing more fully this model of acorporate economy, it may be useful to contrast itsmicro foundations with the orthodox theory of thefirm. The first important difference is that theorthodox theory is not set within an input-outputframework. The significance of this difference canbe fully appreciated only when, as in the sectionwhich next follows, the behavior of the economy asa whole is analyzed macrodynamically. Suffice it fornow to point out that the absence of an input-output framework forces the macroeconomicanalysis into one or the other of the two modes thatcharacterize the orthodox approach: either a gener-al model involving all n industries but with no

P

ACF' AVC'+ AFC'PI

' 60 80 100 ERC

Figure 8

clearly defined technology and indeed with no realproduction system; or, alternatively, a partialmodel with each industry analyzed independendent-ly of every other industry. The first approach is, ofcourse, the one favored by neo-Walrasians and thesecond, the one favored by latter-day Marshallians.Since the neo-Walrasian model is a model ofexchange rather than a model of production and noteven its most ardent enthusiasts would claim that itapplies to the real world, it is the Marshallianmodel, the model that dominates the intermediatelevel macroeconomic theory textbooks, that will beused as the point of contrast with the model of acorporate economy outlined in the preceding sec-tion. The Marshallian model, it should be noted,starts out with the disadvantage that, not being setwithin any larger framework, the results establishedat the firm or industry level cannot be extrapolatedto the economy as a whole. Its greater realism

compared with the neo-Walrasian modelis

there-fore at the expense of its generality.Aside from the larger framework, the next most

important difference between the Marshallian mod-el which dominates the orthodox macroeconomictextbooks and the model of a corporate economyoutlined above is the nature of the representativefirm. Instead of a megacorp, the Marshallian modelassumes a family-controlled proprietorship to bethe typical form of business enterprise. Thisdifference in the nature of the representative firmthen leads to the following differences in the model

itself.(1) The goal of the firm is short-run profitmaximization rather than the highest possible rateof expansion by the firm itself. In seeking to achievethis goal, the key decisions are made by theindividual who, as paterfamilias, is the firm'sowner-entrepreneur. There is no executive groupsharing the decision-making power (although theremay be one or two partners), and there is nolower-level group of managers to help in runningthe firm. The emphasis on short-run profits reflectsboth the uncertain future of the firm and the direct

personal interest the owner-entrepreneur has in theamount of net revenue being earned. Without aprotected market position, the firm cannot be sureof surviving far into the future, and the owner-entrepreneur therefore prefers to maximize themore immediate returns which, unlike any corpo-rate cash flow in the case of the executive group,accrue to him directly.

(2) The proprietary firm, since its management islimited to one or two owner-entrepreneurs, iscapable of operating only a single plant - whichmeans that it is subject to decreasing returns whenit expands output beyond a certain point. This givesrise to the familiar set of U-shaped cost curvesfound in intermediate level textbooks, with margin-al, average variable and average total costs all risingwithin the relevant range. The technical coef-cients, rather than being fixed, are sufficiently





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flexible to accommodate varying combinations oflabor and material inputs, so that, even with but asingle plant, output can be varied in the short run.Indeed, it is the need to offset the fixity of thecapital inputs in the short run by relying on greaterquantities of the variable inputs which accounts forthe decreasing returns as output increases beyond acertain point. In the longer run, expansion takesplace, not by the addition of new plants to existingfirms but rather by the entry of entirely new firms,each with a single plant.

(3) The proprietary firm may be a price taker aswell as a price setter-with the former the morelikely case. If the firm is a price taker, implying thatit supplies an insignificant portion of the totalmarket, it will have no real control over prices,which are determined by supply and demandfactors at the industry level. The firm's owner-entrepreneur can only decide how much to

produce, throwing that output on the market forwhatever price it will bring. But even if the firm is aprice setter, announcing in advance the set of listprices at which it is prepared to sell its output, thecompetition from other firms, both existing andpotential, will be sufficient to prevent that set of listprices from exceeding the costs of production. Itcan therefore be assumed that the mark-up will bereduced to zero in the long run.

(4) Shaving the price is the only form thatcompetition among existing firms takes. There is noadvertising or R & D budget. While the firm may,

from time to time, purchase new equipmentfinanced through bank loans, there is no regularcapital budget either. Investment is episodic, withthe critical decisions being the one to enter theindustry in the first place and then, when the firmcan no longer compete effectively with the vintagecapital stock it owns, the decision to retire from theindustry.

(5) The proprietary firm therefore makes onlyone type of decision continuously over time. This isthe decision of how much to produce, and it is adecision which the owner-entrepreneur himself willmake by comparing the marginal cost of theadditional output with the marginal revenue whichcan thereby be earned. The owner-entrepreneur,by not allowing the marginal cost to exceed themarginal revenue, can be assured of maximizing hisshort-run profits through the one means he has ofinfluencing that goal, to wit, by varying the firm'soutput. The pricing decision is largely in the handsof an impersonal market, even when the firm isnominally able to set prices in advance. Investmentoccurs too infrequently even to be analyzed as partof the normal decision-making process, and when itdoes occur, the firm can be expected to rely onbank financing because the firm's inability tomaintain a mark-up in excess of costs prevents itfrom generating the funds internally -except as awindfall from unexpectedly high levels of demand.

The contrast between this Marshallian model and

the model of a corporate economy presented earlieris clear, and there seems little point in asking whichcorresponds more closely to what can be observedin the real world. The one thing that can be said forthe Marshallian model is that it can easily begrafted on to the other model by identifying theprimary producers in the latter with the proprietaryfirms which are price takers and the retail distribu-tors with the proprietary firms which are pricesetters. In this way, the model of the corporateeconomy can be further developed to include adescription of its primary and retail distributionsectors, while the Marshallian model is limited towhat it correctly describes - the peripheral sectorsof the corporate economy.

THE CORPORATE ECONOMY AT THEMACRO LEVEL

One test of how useful this model of the corporateeconomy might be is how well it can serve asthe macroeconomic foundation for macrodynamicanalysis. Can it account for some of the stylizedhistorical facts of recent years-in particular, thesecular rise in prices, together with the unevenexpansion of the national economy? This is theexercise that will be carried out in this next sectionof the paper.

It is necessary to distinguish, at the outset, the

types of unforeseeable events, and hence thesources of uncertainty and instability, which origin-ate within the corporate economy as has just beendescribed and the types of unforeseeable eventswhich originate from without. The former fall intotwo sub-categories: (1) major product innovations(those which lead to a change in the number of kindustries), and (2) a change in the market positionof the firms within any of those k industries as aresult of non-price competition. The second type ofunforeseeable event includes a change in either therate of growth or in the composition of demand forthe goods and services purchased by the govern-ment (or, for that matter, insofar as the model is anopen one of a less than global system, in the rate ofgrowth and composition of net exports). It alsoincludes any other changes in the government'seconomic policies, such as a less accommodatingstance by the central bank or a revision of taxschedules. (Unforeseeable changes in householdspending patterns can be assumed not to occur,those patterns being determined entirely by therelevant set of income and price elasticities ofdemand as real wages and other forms of householdincome increase over time.) The absence of uncer-tainty in the model implies that none of the aboveunforeseeable events occurs, both those whichmight have their origins within the corporateeconomy and those which might have their originswithout. At the outset, primarily for heuristic

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purposes, the analysis will be carried out on thepresumption that uncertainty in this sense does notexist. Later this restriction will be relaxed to showwhat happens when major product innovations,inter-firm competition and changes in governmentpolicy are introduced into the model.

In the absence of uncertainty in the sense justdefined the corporate economy can be expected toexpand along a steady-state growth path that isdetermined by the growth of real income within thehousehold sector (Pasinetti, 1981). It is the growthof real income within the household sector which,interacting with the various income elasticities ofdemand, will principally determine the growth ratesfor each of the k industries-both directly in thecase of the h industries producing goods for finalconsumption and indirectly in the case of the k-hindustries producing capital goods and materialinputs. It is the growth rates for each of these kindustries which, when weighted and

addedtogether, will give the aggregate growth rate or rateof steady-state expansion, G. The growth of realincome within the household sector will, in turn,depend on the growth of output per worker, Z.While it will make some difference how that incomeis distributed within the household sector betweenworkers and non-workers if they have differentmarginal propensities to consume (the latter groupincluding stockholders and other rentiers as well astransfer payment recipients), this complication canbe avoided by assuming that, whatever the distribu-

tion of income within the household sector, it willremain unchanged over time. On this assumption,the steady-state growth path is determined ulti-mately by the growth of output per worker.

How to explain the growth of output per workerin the absence of major product innovation issomewhat of a problem, and indeed the problemitself provides an important insight into the natureof the corporate economy. For now it will sufficesimply to say that, as part of their non-pricecompetitive strategy, the firms in the capital goodsindustries continually expand their product line to

include new types of equipment which, whenpurchased by other firms, enable them to reducetheir labor technical coefficients and hence theirlabor-output ratios. In this way, it is possible topostulate a certain rate of technical progresswithout introducing the further complication, atleast at this time, of major product innovations. Onthis basis it can be assumed that the corporateeconomy, consisting of the k oligopolistic industriesand the n - k other types of industries, is expandingalong a steady-state growth path, G, which is equalto, and determined by, the growth of output perworker in the aggregate, Z.

Not all n industries will be expanding at the samerate, however. The rate of expansion for anyparticular industry, gj, will depend on the incomeelasticity of demand for the final goods and servicesit either produces directly (if it supplies goods for

final consumption) or indirectly (if, alternatively, itsupplies capital goods or material inputs). Todetermine the growth rate for any particularindustry, it is necessary to scale the average rate ofexpansion, G, by the income elasticity of demand,ri,, for each of the goods and services that enterinto final consumption. Thus, for final goods andservices with income elasticity of demand greaterthan 1, the growth of demand over time will begreater than G, and for final goods and serviceswith an income elasticity of demand less than 1, thegrowth of demand will be less than G. A finaldemand growth vector, consisting of the elementsG(,qj), can then be multiplied by the Leontiefinverse, (I- A)-', to give the rate of expansion, kj,for each of the n industries, both the h industriesproducing items for final consumption and then - h industries producing intermediate goods. Thisrate of expansion kj, is the rate at which the total

output of each industry, Qj, will need to increase,based on the direct and indirect demand for itsoutput, as the demand for all items of finalconsumption expands over time.

The rate of expansion for each of the nindustries, kj, is one of two factors which will thendetermine the mark-up which needs to be estab-lished in each of those same n industries, mj, if theinvestment necessary to enable the corporate eco-nomy to continue expanding at the steady-state rateis to be financed (Eichner, 1982). The other factordetermining the size of the mark-up is the in-

cremental capital-output ratio, vj, for each of thesame n industries. With each industry expanding ata rate equal to kj, plant capacity will need toincrease by the same percentage if the growth ofoutput is to keep pace with the growth of demand.With an incremental capital-output ratio equal tovj, this means that the industry's outlays on newplant and equipment at any given point in timemust be equal to kjvj, or, dropping the subscriptsand superscripts, gv. If investment outlays equal tothis amount are to be financed, either concurrentlyout of cash flow or with payment stretched out over

time through an increase in debt service, then theprice charged by the industry must exceed the directcosts of production by an amount equal to gv. Inother words, the rate of profit, or margin, must beequal to gv. (The margin, M, is the same as theaverage cash flow, ACF, previously identified.)Since the mark-up is equal to the margin, a, dividedby 1 - a, this means that the mark-up, mj, in eachof the n industries must be equal to gv/(1 - gv) ifthat industry is going to be able to finance theinvestment which its expansion over time requires.

Note that it makes little difference to theargument whether the investment is financed inter-nally or externally. While a resort to externalfinancing will make it possible to step up investmentoutlays without immediately increasing the mark-up, the advantage is only a temporary one. If theexternal debt is to be serviced, the mark-up will in

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time need to be the same as it would if theinvestment were being financed concurrently out ofcash flow. It is just that the industry will havegained some time before it need achieve that sizemark-up. However, offsetting the time gained byrelying on external financing is the fact that theindustry will have to obtain the approval of one ormore financial institutions for its investment

plans,thus reducing the freedom of action by the firms inthat industry.

The point is that, with the economy expanding ata certain constant rate, it is the growth rate for eachof the individual industries, g, together with theincremental capital-output ratios for each of thosesame industries, v, that will determine the size ofthe required mark-up, m. This is true, withcontinuous expansion over time, irrespective ofhow the accompanying investment is to be financed,whether internally from cash flow or externally

through an increase in debt. If competitive forces,such as those usually assumed in the orthodoxtheory, preclude an industry from achieving thatsize mark-up, then one of the necessary conditionsfor continuous expansion over time will not be met.This point goes far toward explaining why the typeof economic system represented by the orthodoxtheory has evolved into the corporate economy(Eichner, 1969; Chandler, 1977). A mark-up equalto zero in any of the n industries is consistent onlywith a non-expanding industry. While it is possiblefor some industries to fall within this category, and

indeed even to go through a period of absolutedecline, this cannot be true of most industries - notif the system as a whole is to continue expanding. Inother words, the orthodox model is incompatible,at the microeconomic level, with a continuouslyexpanding economy even if one assumes - howeverunrealistically - that all investment is being financedexternally through the 'savings' of the householdsector. With a zero mark-up, an expanding industrywill be incapable of reproducing itself and growingat the requisite rate in value terms. Expansion canoccur, if at all, only through alternating periods of'boom' and 'bust', the former assuring the neces-sary financing, as a result of the temporary increasein the mark-up, for the investment that mustaccompany the expansion and the latter serving toreduce the mark-up to the zero level required bythe other long-run equilibrium condition of themodel.

With the size of the mark-up, m, for each of the nindustries explained, one need only add an explana-tion of what determines unit labor costs so as to beable to explain what determines the set of relativeprices, or price vector, that will need to beestablished within the expanding system. Unit laborcosts, together with the mark-up, will determine thevalue added per unit of output in each of the nindustries, and this value added vector, multipliedby the Leontief inverse, (I-A)-1, will yield therequired price vector. Unit labor costs will, in turn,

depend on two factors: (1) the set of labor technicalcoefficients for each of the n industries, indicatingthe quantity of labor inputs (in hours) needed toproduce a given amount of output, and (2) themoney wage rate. Indeed, the unit labor costs foreach of the n industries will simply be the productof these two factors, w(lj), where w is the money

wagerate

(assumedto be the same for all n

industries, although this assumption can easily berelaxed) and lj is the labor technical coefficient foreach of the n industries. These unit labor costs, inconjunction with the mark-up, mj, and the Leontiefinverse, (I-A)-1, are then sufficient to determinethe price vector, P, for the corporate economy.

Based on the set of labor coefficients, lj, it ispossible to define a rate of growth of output perworker in each of the n industries, zj. The rate atwhich the labor coefficient becomes smaller overtime, as the result of technical progress, can be

represented by a negative growth rate, and theabsolute value of this growth rate (that is, with thesign omitted) is the value of zj. This rate of growthof output per worker in each of the n industries canthen be compared with the growth of output perworker, or the rate of technical progress, within thesystem as whole, Z, the latter being the weightedsum of the growth of output per worker in each ofthe n industries, zj. The rate of technical progress isunlikely to be the same for all industries. Thismeans that some industries will experience above-average rates of growth of output per worker. For

these industries, zj - Z will be positive and, withthe money wage rate the same for all industries,their unit labor costs will be declining relative to theaverage for the systen as a whole. Other industrieswill experience below-average rates of growth ofoutput per worker. For them, j - Z will benegative and, as a result, their unit labor costs willbe increasing relative to the average.

The extent to which each industry's unit laborcost, w(lj), are falling or rising relative to theaverage - depending on whether zj - Z is positiveor negative - will be the primary factor determiningthe change in the corporate economy's price vectorover time. While a change in the growth rate forany of the n industries, gj, will also lead to a changein the price vector (due to its effect on the size ofthe required mark-up), this possibility can beexcluded, at least for the moment, by the steady-state expansion being assumed. Different growthrates for each of the n industries may be consistentwith a constant rate of expansion for the system as awhole, but a change in any one of those industrygrowth rates is not. A change in any of the nindustries' incremental capital-output ratio, vj,although it would also affect the size of the requiredmark-up, is less likely than a change in the industrygrowth rate; and, unless the change in vi was at aconstant rate, it, too, would be inconsistent with asteady-state rate of expansion for the economy as awhole. On these grounds, the change in the

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corporate economy's price vector over time can besaid to depend primarily on what is happening toeach industry's unit labor costs, based on thegrowth of output per worker in that industryrelative to the average, Zj - Z.

Any such change in the corporate economy'sprice vector will be an additional factor, besides thegrowth of household income, in determining therate of expansion for each of the n industries, gj.The growth rate for each industry given by rj(G)will be either boosted or reduced by a factor equalto ej(j - Z), where ej is the price elasticity ofdemand for each of the goods or services producedby the n industries. This is because j - Z willcorrespond to the change in the industry's relativeprice over time, and this change in relative price,together with the price elasticity of demand, willdetermine the change in relative demand for thatindustry's output. With j - Z taking a positive

value, implyinga relative decline over time in both

unit labor costs and in the price that will need to becharged, the industry growth rate will be boosted,beyond what it would be from the value of r/j (G)alone (or since G can be assumed to be equal to Z,from the value of rj(Z) alone). Conversely, withZj Z taking a negative value, implying a relative

increase in unit labor costs and the price that willneed to be charged, the industry growth rate will bereduced below what it would otherwise be. Howmuch the industry's growth rate will be eitherboosted or reduced will, of course, depend on the

price elasticity of demand, ej. What this means isthat the growth rate for each of the n industries, gj,will depend on not just one but two sets of factors:the relative increase in output per worker, ij - Z,multiplied by the price elasticity of demand, ej, aswell as the increase in output per worker for theeconomy as a whole, Z, multiplied by the industry'sincome elasticity of demand, rj1. However, since rjis generally greater than ej and ij - Z is unlikely toexceed Z, it follows that the change in relativeprice-what can be termed the substitution effect-will only modify what is the principal determinant

of the industry growth rate, the growth in house-hold income. It is for this reason that the possiblesubstitution effect is introduced only now as a quali-fication to the earlier argument.

So far only the set of relative prices, or pricevector, for the corporate economy has been ex-plained. To derive the set of actual prices for eachof the n industries, pj, it is necessary to specify andaccount for the money wage rate, w, as well. Thatmoney wage rate serves as the numeraire for thesystem as a whole, and thus is the basis forconverting the set of relative prices into a set ofactual prices. Any money wage rate, w, togetherwith a set of labor technical coefficients, lj (which,as a group constitute the vector of labor coef-cients, L), and a set of required mark-ups mj(which, again as a group, constitute the vector ofrequired mark-ups, M), will be sufficient to produce

the value added vector, V. That is, V = wL + M.This value added vector, in turn, when multipliedby the Leontief inverse, (I - A)-1, will produce thevector of actual prices that will need to beestablished within the corporate economy. Theweighted average of these actual prices constitutesthe corporate economy's price level, P.

The link between the money wage rate and theprice level can be seen more clearly by transformingthe Leontief model of production which has beenrelied upon up to this point, based on othertechnical coefficients besides the labor ones, into avertically integrated model of production in whichall the other technical coefficients are replaced by asingle labor coefficient for each of the h industriesproducing items for final consumption, (Pasinetti,1980, 1981). This single labor coefficient, ii',represents not just each industry's direct laborrequirements but its indirect labor requirements aswell-the labor needed

directlyand

indirectlyto

produce any material inputs. Since the Leontiefinverse is the basis for deriving these verticallyintegrated labor coefficients, Ij' (which, as a group,constitute the L' vector, as well as the accompany-ing set of vertically integrated mark-ups, mj'(which, as a group, constitute the M' vector), itneed not otherwise be taken into account. Thevector of actual prices which will need to beestablished within the corporate economy (for the hindustries producing items for final consumption) issimply the product of the wage rate and the vector

of vertically integrated labor coefficients plus thevector of vertically integrated mark-ups. That is,P = wL' + M'.

Since the set of vertically integrated laborcoefficients, represented by the L' vector, isdetermined solely by the prevailing technologywhile the set of vertically integrated mark-ups,represented by the M' vector, depends solely on theeconomy's rate of expansion (along with the socialrate of return on investment, or the inverse of theincremental capital-output ratio in each of the nindustries), it follows that any change in the pricelevel over time will necessarily be due to a changein the money wage rate. More specifically, thegrowth in the price level will depend on the growthof money wages, w, relative to the average growthof output per worker, Z. With money wagesincreasing more rapidly than the growth of outputper worker on the average, the n industries willneed to increase their prices on the average by thedifference between the two growth rates if they areto cover the increase in their wage bill. That is,P = w- Z. It is, of course, possible for the growthin money wages to be less than the average growthin output per worker. But in that case, householdincome will not be increasing at a rate sufficient tomaintain the growth in demand for items of finalconsumption which the steady state expansion ofthe corporate economy requires. The argument thatthe growth in the price level depends on the

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difference between the growth in money wages andthe growth in output per worker is therefore subjectto the important qualification that the growth inmoney wages must be equal to or greater than thegrowth in output per worker. Otherwise, one of theessential conditions for the steady state expansionof the economy will not be satisfied. This indicatesboth what can bring the longer secular expansion ofthe economy to a halt and what is the conditionunder which a secular rise in the price level canoccur.

With the growth of output per worker given oncethe corporate economy's steady-state rate of expan-sion has been determined, it follows that the growthin the price level, P, will vary over time, dependingon the growth of money wages, fv. This raises thequestion of what determines the growth of moneywages. The orthodox theory asserts that it dependson (1) the growth of the money supply, (2) the rate

of unemployment or (3) both (as in the argumentsmade about the 'natural rate' of unemploymentwithin the context of a monetarist explanation ofinflation). The alternative post-Keynesian explana-tion is that the growth of money wages depends onthe wage norm adopted by trade unions in collec-tive bargaining. The trade unions are assumed tohave sufficient power that whatever wage normthey adopt as their own will then determine thegrowth of money wages within the corporateeconomy. Indeed, the growth of money wages willbe equal to this wage norm plus any 'wage drift'.

Although the rate of unemployment (though notthe growth of the money supply) may be one of thefactors influencing the wage norm and thus thegrowth of money wages, the point is that the wagenorm is not uniquely determined by any set ofeconomic factors. It depends on a broader set ofsocio-political factors - and thus can take a widerange of values independently of either the unem-ployment rate or the growth of output per worker.

This explanation of what determines the growthof money wages, when incorporated into the modelof a corporate economy, suggests why such aneconomy may be susceptible to a secular rise in theprice level. According to the model, it is necessaryonly that the growth of money wages, which areexogenously determined, exceed the growth ofoutput per worker - the difference between the twobeing the rate of inflation (Weintraub, 1959, 1966).Indeed, the corporate economy would seem to beconfronted by a second type of 'knife-edge' prob-lem besides the one first pointed out by Harrod(1939, 1948; see also Kregel, 1980). If the growth ofmoney wages, fv, is less than the growth of outputper worker, Z, the system's continuous constantrate of expansion cannot be maintained; if, on theother hand, iV s greater than Z, a secular rise in theprice level cannot be avoided. Only if iV shouldhappen to be the same as Z is a steady-state rate ofexpansion with price stability possible. However,there is nothing in the nature of the corporate

economy which would assure this result. With therate of growth of money wages dependent on wagenorms which are determined by socio-politicalrather than economic factors, the greater likelihoodis that fv and Z will each take a different value.

THE CORPORATE ECONOMY WITHUNCERTAINTY

The model just presented may provide a crucialinsight into the nature of the inflationary problemfaced by the American and other advanced marketeconomies. However, the condition of steady stateexpansion which has been imposed, while simplify-ing the argument considerably, precludes an ex-planation of the other stylized fact of recent

historical experience - the uneven rates of expan-sion by those same economies over the past severaldecades. Moreover, the argument may need to bemodified once a steady state rate of expansion canno longer be assumed. It is therefore necessary torelax the assumption of a continuous constant rateof expansion by introducing, in succession, each ofthe three types of unforeseeable events which canbe expected to displace a corporate economy fromits steady-state growth path. These three types ofunforeseeable events as already indicated, aremajor product innovations, inter-firm competition

and changes in government policy. Only afterelaborating on the model to include uncertainty inthis precisely defined sense will it be possible to seewhat changes, if any, need to be made in theexplanation just offered of what causes the secularrise in the price level within a corporate economy.

Major product innovations will lead to theemergence of entirely new industries, and thus to achange in the number of industries which comprisethe corporate economy. If the product innovationsoccur continuously, they will make each of the nindustries subject to a 'product life cycle' of youth,maturity and decline (Ong, 1981; Shapiro, 1981).An industry, upon first emerging in the wake of amajor product innovation (such as the developmentof railroad transportation, electrically poweredmotors or computers), will experience a period ofrapid expansion during which the industry's growthrate will exceed that of the economy as a whole asthe product it supplies gradually succeeds indisplacing an older group of products. The newproduct will displace the older group of productsbecause of the entirely new uses to which it can beput and/or because of the lower cost at which it nowenables an older set of needs to be met. This initialperiod of rapid growth will be followed by a periodof maturity -the onset of which will be marked bythe stabilization of market shares among a limitednumber of firms and during which the industry'sgrowth rate will more closely approximate that of

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the economy as a whole. A final period of decline,during which the growth rate will fall significantlybelow that for theeconomy as a whole, perhapseven turning negative with the industry eventuallydisappearing, will complete the product life cycleand hence the life cycle of the industry itself.

The life cycle of individual industries whichfollows from recurrent product innovation will,when introduced into the model of a corporateeconomy, have two consequences of note. First, itmeans that the growth rate of individual industries-though not necessary of the economy as awhole - can no longer be assumed to be constantover time. Indeed, that growth rate, ki, can beexpected to accelerate initially, slow down subse-quently and then actually fall corresponding to eachindustry's period of youth, maturity and decline. Asalready implied, this variation in the industrygrowth rate over time will affect the size of the

required mark-up, mi, and hence produce a slightchange in the corporate economy's price vector. Itwill also, of course, require a change in the rate ofinvestment within the same industries. Still, therewould appear to be no reason why these adjust-ments in the other variables in the system which thevariation in kj over time will necessitate cannot bemade without interrupting the continuous constantexpansion of the system as a whole. The adjust-ments in both the size of the mark-up and the rateof investment within individual industries will, afterall, be slow and gradual. The second consequence

of the recurrent product innovation will be theeffect it is likely to have on the nature of inter-firmcompetition. Indeed, this second consequence fol-lows from the first.

With recurrent product innovation, the megacorpcan no longer expect to continue expanding, oreven to survive, simply by retaining its share of themarket in the industries to which it already belongs.Eventually, unless it succeeds in entering otherindustries - those which, being relatively new, aregrowing more rapidly than the economy as a wholeand which, moreover, have not yet settled downinto a stable oligopolistic pattern with fixed marketshares - the megacorp will decline along with theindustries in which it remains rooted. The competi-tion among firms which is crucial to the megacorp'slong-term viability is therefore the competition togain a foothold in the newer, more rapidly growingindustries, so that, despite the life cycle of indi-vidual industries, the megacorp can continue ex-panding at the same rate as the economy or better.This competition will add significantly to theclimate of uncertainty in which the megacorp, at themicro level, is forced to operate.

The uncertainty for the individual firm within oneof the k oligopolistic industries will already begreater than for the industry as a whole. This isbecause of the possibility that market shares may,in fact, change over time. Adding to the uncertaintyfaced by the individual firm is the possibly dis-

appointing results from other types of investment,both any effort that might be made to reduce costsby replacing obsolescent equipment and any effortthat might be made to strengthen the firm's marketposition through advertising, R & D and similartypes of outlays. Not only are the returns frominvestment difficult to estimate, so, too, are theimplicit costs of obtaining additional investmentfunds by increasing the mark-up within the indus-try. The long-run price elasticity of industry de-mand, the probability of entry by other firms andthe likelihood of government intervention can onlybe guessed at. Still, as great as the uncertainty maybe for the individual megacorp when it comes tocommitting itself in the way it must within one ofthe mature oligopolistic industries to which italready belongs, the uncertainty will be consider-ably less than that surrounding an effort by thatfirm to expand into a newer, more rapidly growing

industry. This is because a megacorp intent ondiversification has no way of knowing how manyother firms are planning a similar move. Indeed, itmay well be that only some of the firms preparingto enter the industry will be able to obtain theminimal market share they need in order to reachan efficient scale of operation, and this means thatthe other firms planning to enter the industry willbe forced eventually to write off the investment as aloss.

Thus the corporate economy appears quite diffe-rent from the micro perspective of an individual

megacorp faced with the unforeseeable outcome ofinter-firm competition- to gain a share of thenewer, more rapidly expanding industries if not justto retain its share of the older markets - than it doesfrom the macro perspective of someone viewing thesystem as a whole. Both the climate of uncertaintyin which the individual megacorp finds itself and thestability of the system as a whole are, however, partof the same reality - the inter-firm competition(through investment, not price) being the source ofthe energy that drives the corporate economyforward along its steady-state growth path. It is justthe difference in perspective that accounts for thetwo opposing views.

The result, so far, of introducing product innova-tion and inter-firm competition into the model of acorporate economy has been only to approximatemore closely the climate of uncertainty in which themegacorp, at the micro level, is forced to operate.The macro model itself remains largely the same. Inparticular, there appears to be no reason to dropthe strong assumption of steady state expansion bythe system as a whole. The greater uncertaintysurrounding investment when product innovationand inter-firm competition are taken into accountcan be assumed to be insufficient by itself toproduce any systematic cyclical movement in theeconomy. While investment in the newer industrieswhich have not yet matured into stable oligopoliesmay be uneven, these industries are likely to

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account for too small a share of total investment tocause the economy as a whole to deviate significant-ly from its steady-state growth path. The failedexpectations from other types of investment, mean-while, are likely to largely offset one another- atleast within the oligopolistic sector. To provide acredible explanation for the uneven rates of expan-sion actually experienced by the American andother advanced market economies, it is thereforenecessary to introduce a third type of unforeseeableevent - a change in government policy. First,however, it is necessary to introduce governmentitself into the model.

The government can be assumed to purchase acertain portion of the goods entering into finalconsumption, paying for these items out of its taxrevenues plus whatever sums it, like the megacorp,chooses to borrow. There are thus three facets tothe government's fiscal policy: (1) determining the

level of the government's expenditures; (2) estab-lishing one or more tax rates and (3) managingwhatever debt has been accumulated. In addition,the government can be assumed to affect, throughthe open-market operations of the central bank, thegrowth in reserves by the commercial bankingsystem. The extent to which it is willing toaccommodate the need of the banking system foradditional reserves is the nub of the government'smonetary policy (Forman, Groves and Eichner,1982). Either or both of these two types of policycan be used by the government to slow down the

economy's rate of economic expansion. The gov-ernment can be expected to take this step if it hasbeen persuaded by economists that the reason forthe secular rise in the price level is the 'excessdemand' generated either by too large a budgetdeficit and/or by too rapid a growth in the moneysupply. While the accompanying cyclical downturnwill have little effect on the price level - the rate ofinflation is determined, within the model, by thegrowth of money wages relative to the growth ofoutput per worker and the cyclical downturn needhave no effect on the growth of money wages-itwill lead to a fall in real output and employment.

More important, insofar as the megacorp itself isconcerned, the politically induced business cyclewill add to the climate of uncertainty in which thefirm must operate. Now, besides guessing correctlywhat are the newer, more rapidly growing indus-tries into which it must eventually expand, themegacorp must gauge the impact of the govern-ment's policies. In particular, it must be careful notto confuse a cyclical movement around the trendwith a change in the trend itself. If, on the onehand, the megacorp views the slowdown in theeconomy as just another cyclical movement when infact it portends a decline in the secular growth rateand, based on this false reading, it continuesexpanding capacity at the same rate, the megacorpwill find itself with more capacity than it would liketo have, even taking into account its need for a

certain amount of reserve capacity. If, on the otherhand, the slowdown is thought to represent adecline in the secular growth rate when in fact it isno more than just another cyclical movement, themegacorp may fail to expand its capacity as rapidlyas the growth of industry sales requires. Whatmakes it so difficult for the megacorp to correctlyjudge the situation is that whether the slowdown isjust another cyclical movement or an actual changein trend will depend on what subsequent actions thegovernment takes. If the government acts quicklyand decisively to reverse its policies, the upshot willbe little more than just another cyclical fluctuationin economic activity. However, if the governmenthesitates and then only languidly applies thenecessary contra-cyclical antidote, the result will bea decline in the secular growth rate.

A similar type of confusion between a cyclicalmovement and a change in trend can touch off the

wage-price inflationary spiral in the first place. Asthe economy recovers from a cyclical downturn,corporate cash flow can be expected to increasedisproportionately. To the megacorp, this dis-proportionate rise in cash flow will merely offset thedisproportionate decline in cash flow will merelyoffset the disproportionate decline in cash flowwhich, together with the cyclical downturn, pre-ceded it. However, the trade unions, in coming tothe bargaining table to negotiate a new laborcontract, may view the disproportionate rise in cashflow as an increase in 'capital's share' at the expense

of labor and may insist on a more rapid rise inmoney wages. In other words, the trade unions mayregard the disproportionate rise in cash flow asportending an increase in the secular growth ratewhile to the megacorp, the increased cash flow issimply part of the investment funds it must generateover the cycle to be assured of adequate financingfor its capital budget. If the trade unions nonethe-less succeed in obtaining their demands, the mega-corp will feel that its unit labor costs have risen bythe difference between the newly negotiated growthof money wages and the growth of output perworker, and it will insist on raising its prices accor-dingly. This rise in prices by megacorps in generalwill be viewed by the trade unions as reducing thereal income of their members and, when the pre-sent contract expires, will be used by them as anargument for an even more rapid rise in moneywages. In this way, a wage - price inflationary spiralcan be touched off without any one party, either themegacorp or the trade unions with which it negoti-ates, being directly responsible. The underlyingcause is a different judgment as to the secular orcyclical nature of the change in the rate of economicexpansion.

It is, of course, the government that will have thefinal word in this matter. Depending on how soon itagain changes its policies to slow down theeconomy, this in a vain effort to bring theinflationary spiral under control, it will produce

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either just another cyclical movement around thesame trend or a change in the trend itself. Thus byintroducing into the model of a corporate economythe third, and final, type of unforeseeable event - achange in government policy - not only is it possibleto explain what causes the uneven expansion ofadvanced market economies over time, it is alsopossible to shed some further light on the nature ofthe wage-price inflationary spiral in which thoseeconomies find themselves trapped. When thegovernment responds to the inflationary situationcreated by a rate of growth of money wages inexcess of the growth of output per worker bydeliberately slowing down the -economy, one islikely to observe not just continued inflation but adecline in economic activity as well.

By introducing into the model still other types of

unforeseeable events - such as an unusually poorharvest that drives up the price of food or a shift inthe terms of trade (through the emergence ofOPEC or some similar cartel among primaryproducers) that increases the cost of imported rawmaterials - one can point out additional ways inwhich a wage-price spiral can either be touched offor exacerbated. Whatever the origins or

furtherstimulus to a wage-price spiral, however, thegovernment's response of slowing down the rate ofexpansion by the corporate economy will onlycompound the problem of inflation by creating theproblem of a cyclical downturn or, even worse,secular stagnation (Eichner, 1980). In this way, themodel of a corporate economy is able to fully accountfor the recent experience of the American andother advanced market economies.

NOTES

1. Marris, 1963; Marris and Wood, 1971; Baumol, 1967;Wood, 1975; J. Williamson, 1966.

2. Simon, 1955; Cyert and March, 1963; Monsen andDowns, 1965; 0. Williamson, 1964. The work of theparallel British group includes Andrews, 1949, 1964;Andrews and Brunner, 1975; Wilson and Andrews, 1951;Downie, 1958; Wiles, 1956; Penrose, 1959; Loasby, 1976.

3. Means, 1962; Kaplan et al., 1958; Clark, 1961.4. Kalecki, 1954; Sraffa, 1960; Steindl, 1952; Robinson,

1962; Sylos-Labini, 1962, 1974; Vickers, 1968; Eichner,1973, 1976, Pasinetti, 1981; Harris, 1974; Coutts, Godleyand Nordhaus, 1978.

5. Strictly speaking, the vintage equipment means that thefirm's average variable costs will rise as its reservecapacity is tapped. However, the rise in average variablecosts is likely to be slight and, in any case, will beoutweighted by the fall in average fixed costs because ofthe greater volume.

6. The prices of certain items may have to be adjusted morefrequently because of 'competitive conditions'. But theprice list as a whole is likely to be retained even if thediscounts off the list price become large and generallyknown.

REFERENCES

P. W. S. Andrews (1949). Manufacturing Business, Macmil-lan (London).

P. W. S. Andrews (1964). On Competition in EconomicTheory, Macmillan (London).

P. W. S. Andrews and Elizabeth Brunner (1975). Studies inPricing, Macmillan (London).

W. J. Baumol (1967). Business Behavior, Value and Growth,Harcourt, Brace and World (1st edn, 1959, Macmillan).

J. M. Blair (1972). Economic Concentration, Harcourt, BraceJovanovich.

J. M. Blatt (1983). Dynamic Economic Systems, A Post-Keynesian Approach, Sharpe.

A. D. Chandler, Jr (1977). The Visible Hand, The ManagerialRevolution in American Business, Harvard UniversityPress.

J. M. Clark (1961). Competition as a Dynamic Process,Brookings Institution.

K. Coutts, W. Godley and W. Nordhaus (1978). Pricing n theUnited Kingdom, Cambridge University Press.

R. M. Cyert and J. G. March (1963). A Behavioral Theory ofthe Firm, Prentice-Hall.

J. Downie (1958). The Competitive Process, Duckworth.A. S. Eichner (1969). The Emergence of Oligopoly, Sugar

Refining as a Case Study, Johns Hopkins Press (1978,Greenwood Press.)

A. S. Eichner (1973). A theory of the determination of themark-up under oligopoly. Economic Journal, December.

A. S. Eichner (1976). The Megacorp and Oligopoly, MicroFoundations of Macro Dynamics, Cambridge UniversityPress.

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