Budget Constraints and Business Enterprise: A Veblenian Analysis

By Wilson, Matthew C. | Journal of Economic Issues, December 2006 | Go to article overview

Budget Constraints and Business Enterprise: A Veblenian Analysis


Wilson, Matthew C., Journal of Economic Issues


"It takes money to make money" as Poor Richard might say. Business opportunities multiply as the capital at hand increases, whereas they dwindle to little or nothing when capital is relatively insubstantial. While this aphorism, qualified in one way or another, sustains wide credence perhaps even among economists, it is not always recognized that it stands in conflict with the normative ground of property rights under the canons of classical thought. In the classical tradition, the productivity of real resources (in classical theory: labor; in neoclassical theory: land, labor, and capital) is the normal ground, both actual and legitimate, of the ownership of wealth and receipt of income. Thus productivity is the "normal basis" for the consumer's budget constraint.

The premise that "it takes money to make money" upsets this classical postulate, because it implies that the strategic use of money assets is a means to acquire more money assets, in which case money has real causal force, both in the acquisition' of income and in the control of productive enterprise. That being the case, one could not hope to reduce the sources of individual wealth to expenditures of productive force.

The paper shows that the Veblenian critique can be used as the basis for a critique of the neoclassical treatment of budget constraints. It is argued that the structure of neoclassical producer and consumer theory sustains this underlying canon of classical thought. The latent influence of this canon can be seen in the asymmetrical treatment of budget constraints. The neoclassical consumer faces a budget constraint, which, it is strongly suggested, is somehow derived from the productivity of his land, labor, and capital. However, the neoclassical producer faces no comparable budget constraint on his productive enterprise.

I am using the phrase "budget constraint" here as analogous to the consumer's budget constraint, which is an amount of money assets that the consumer has before the purchase of output, which constraints the purchase of that output. A comparable budget constraint on the firm would be an amount of money assets that the firm has before the sale of output, which constrains the production of that output.

It can be seen that the neoclassical firm does not face a budget constraint in this sense. Rather it is constrained only by the amount of money it receives from the sale of output. In the supply and demand diagram, time is absent. Read literally, this implies that the receipt of sale proceeds is simultaneous with the remuneration of marginal costs incurred. This treatment obviates any role that a budget constraint, or more generally a financing constraint, might play: at the level of the firm, production is self financing.

In this context, if the firm maximizes profits, its production is constrained to be on the optimal isoquant. The producer then faces a series of isocost lines but not a budget constraint. The only long-run constraint on the scale of output achieved by the individual producer is that the firm must minimize long-run average total cost.

If this were not the case, i.e. if the producer faced a budget constraint, then, even in the long run, the scale of output would depend upon pecuniary constraints stemming from the producer's financing sources. In effect, it would "take money to make money," and, from the standpoint of economic theory, the classical canon of the legitimate basis of income and wealth would be vitiated. That is, capital income received would depend not upon productive forces expended but rather upon perspicuous, shrewd or just plain lucky capital investment.

In contrast with neoclassical producer theory, where the firm faces no budget constraint (and thus is unconstrained by its prior accumulation of money and capitalized assets), the paper argues that the more general concept of a financing constraint on business enterprise is essential for an explanation of the evolution of a firm's productive capacity, particularly when the firm faces constant returns to scale.

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