Chapter 5 of Steve Keen’s Debunking Economics is dedicated to explaining Piero Sraffa’s critique of the neoclassical theory of production (Keen cites Sraffa [1926]). Specifically, Sraffa argued that real life firms do not face increasing marginal costs, since real life firms (a) operate with excess idle capacity and therefore (b) the assumption of fixed inputs is unrealistic. The entire chapter is incredibly interesting (and correct), but I’d like to narrow the focus here to a graph included in the book: figure 5.1, p. 114. It deals with capacity utilization, and is an empirical proof of the fact that firms control excess capacity for production. A recreation, based on FRED data, below:

There are several things this graph shows, some examples include: (i) spikes in idle capacity as a common characteristic of industrial fluctuations, (ii) a trend of increasing idle capacity (“great stagnation?”), and (iii) the general fact that idle capacity always exists. Pages 113–115 deal predominately with (iii) and that’s what I seek to address here. The rationale Keen gives for excess idle capacity essentially comes down to the idea it makes sense. The key insight it presumes is that firms are more likely to concentrate labor on fewer machines rather than spread workers around, since this raises productivity (maximizing the production of relatively fewer machines). Finally, they might choose to have excess machinery to be able to expand production if demand for their product rises (rather than having to expand the factory or build a new one).

I want to compliment Keen’s story with a tinge of Hayekian insight (Hayek [1935]), as I think it fits very well into Sraffa’s argument that the neoclassicals had taken the classical concept of diminishing marginal productivity out of context. Keen summarizes Sraffa as positing that the classical law of diminishing marginal returns assumes its application to land rents, where increases in population will require new land to be used. This new land will become progressively of lower quality, since the best quality land is presumably occupied and used first. The same can be true of machinery.

Let’s assume that a capitalist–entrepreneur builds a factory from scratch, which includes x quantity of homogenous machinery. To further simplify the example, further assume that all machines depreciate at the same rate, including non-expected wear and tear. To maintain a certain level of income the capitalist–entrepreneur will have to maintain his stock of capital, which not only refers to repairs but also to replacements. The choice of maintenance will depend on budgetary constraints and expectations, among other things, but let’s assume that our capitalist–entrepreneur decides to exchange ¼ of his equipment with newer models that can produce twice as much output. He does this periodically, such that at some point his machinery has a heterogeneous composition. If we accept this as a logical possibility, then it would make sense for the firm to concentrate its available labor on the best machine, leaving the worst idle.

The point is that not only might a firm start off with idle capacity, but idle capacity may build up due to financial constraints and the gradual upgrade of equipment. It also suggests that machinery might suffer similar diminishing marginal returns as land, although this doesn’t really have any major implications within the context of Keen’s work: changes in “fixed” equipment are still restrained by budgetary constraints. I just thought this would be an interesting “Austrian” take on an, admittedly, small part of Keen’s book (that, on close and objective consideration, would be well received by Austrians).