Remarks on Factory Prices, Production Indicators, and Quality Control

Author(s): Michal Kalecki

Source: Eastern European Economics, Vol. 6, No. 1 (Autumn, 1967), pp. 28-30
Published by: Taylor & Francis, Ltd.
Stable URL: http://www.jstor.org/stable/4379354
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Gospodarka planowa, 1964, No. 5, pp. 26-28

Michal Kalecki

REMARKS ON FACTORY PRICES, PRODUCTIONINDICATORS,

AND QUALITY CONTROL

tionate to costs might require unusually large

investment. This might well be unjustified.
Let us assume, however, that these are exceptional cases and that basically the sale price
could be set in proportion to costs. Another difficulty would still arise. In the context of the
equilibrium between supply and demand, a given

I should like, in a few words, to state my viewpoint on three closely interrelated questions.
1. Factory prices. Comrade Strumin'ski has
put forward the interesting idea that factory
prices might be replaced by sale prices, established in proportion to costs for any given group
of products.
It must be kept in mind, however, that, as
Comrade Strumin'ski pointed out, the purpose of
sale prices is to bring demand into equilibrium
with supply. In this connection, cases may arise
in which, because of the great demand for a certain article, its selling price will be higher than
a price based on costs.
It is sometimes believed that this higher price
should be handed down to the enterprise as an incentive to increase production of the given product. On the other hand, the enterprise may have
limited productive capacity and will be unable to
increase production of this article. It could be
argued further that this would constitute an incentive to obtain the necessary investment funds.
But the increase in output to a scale necessary
to force the sale price down to a level propor-

in some cases

a high - allowance for internal

accumulation should be included in the sale

price. This allowance for investment plays a
very important role in our system of incentives,
based on the increase in profits.
Increased profit depends on the growth of output and a decline of costs. If production rises by
a certain percentage, the absolute increase in
profits will thus be proportional to the profit
margin, whereas the increase in profit resulting
from lowered costs does not depend on that margin. Hence, if the profit margin is high, increases in output are generally well rewarded,
relatively speaking; little attention will be given
to cost reduction. This may lead to a distorted
structure of incentives.
For example, if in the textile industry the size
28

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29

VOL. VI, NO. 1

of the enterprise fund depends on accumulation,
we place a very high premium on growth of output and give little weight to cost reduction: the
opposite is in order. This industry is limited by
the necessity to import raw materials; hence
the structure of incentives should be such as to
emphasize savings on materials rather than an
increase of production. Accordingly, the profit
margin, included in prices which are used to
calculate the increase in profits, should not be
identical with the profit margin included in the
sale prices (allowance for internal accumulation),
but should be set at a relatively low level.
In determining factory prices, we must differentiate the profit margins; the extent of differentiation depends on whether we try to achieve an
increase in output or a decline in costs. The
more we are interested in forcing increased production, the greater must be the margin of profit.
No such guarantees are given by sale prices. As
noted above, incentives based on an allowance
for internal accumulation in the textile industry
result in undesirable consequences.
Hence, I believe that we need factory prices in addition to
sale prices. The profit margins embodied in the
former should be differentiated according to the
branch of production, but for given products
within the branch the margin should be uniform
in principle in order not to create an artificial
advantage for some articles and hence distort
the product mix within the branch.
It has been correctly emphasized that if we
set margins according to those principles at the
outset of a five-year plan, diverse changes in

costs during the five-year period will alter the

existing relationships. A certain minimum number of changes will have to be made in factory
prices during the five-year period in order to
compensate [for cost changes]. For if there are
changes in price inputs used in production of a
given article (including changes in the wage
rates), costs of different articles will be affected
to a varying degree and revision of the factory
prices will be unavoidable.
To my way of thinking, the varying effects of
technological progress on the declining costs of
different articles are not so dangerous, and revision of factory prices may well be confined to

the case of changes in prices of material inputs

or changes in wage rates.
Once the unavoidable changes have been carried out, it is unlikely that there will be any pronounced tendencies toward deformation of the
production structure. That will make it easier
to calculate the enterprise and premium funds,
since it will be unnecessary to reduce the assortment for the sake of comparability and we
shall confine ourselves only to the elimination
of the impact of those changes in input prices and
wage rates that have not yet been reflected in
factory pricing.
2. Production indicators. The question of factory prices also sheds light on the problem of
performance indicators. Recent discussion on
the management of enterprises has been concentrated mainly on selecting suitable productivity
indices. A basic error was apparently committed at the very outset of the discussion. It was
forgotten that a production index is not only an
instrument for corrections of the wage fund, but
also a basic directive index. In the light of this,
the problem of indicators must be considered
from those two points of view.
Fortunately, some very sharp criticisms of the
indices of gross and marketed output were made
during the discussion on proper production indices: these indices are applied as an incentive
for material intensity. If we consider an index of
marketed output weighted by sale prices, there
is the additional problem of its impact on the
product mix, since rates of profit are not the
same for individual products; this often leads to
distortion of the structure of output. It should be
noted that material intensity is a very acute
problem because supply of raw materials is a
major bottleneck in the development of the Polish economy.
In this situation, we should consider it beneficial that various indices proposed at the present
time are at least conceptually neutral with respect to material intensity. These requirements
are met by all types of net production, which
may be divided into three categories:
1. net output obtained as the difference between gross output (in constant prices) and material costs (in constant supply prices);

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30

EASTERN EUROPEAN ECONOMICS

2. net output in constant unit processing costs;

3. output in terms of constant normative labor
costs.
The latter two methods do, of course, eliminate the automatic impact of differentials in the
rate of accumulation on the product mix. On the
other hand, the first method - or the deduction
of the cost of materials used (in terms of constant prices) from the value of gross output in
constant prices - makes it necessary to introduce factory prices which would contain a uniform margin of profit within a given branch. It
is here that we find the connection between the
problem of factory prices and the issue of performance indicators.
What are the advantages and disadvantages of
these three methods?
In the first case (difference between gross output in constant factory prices and material costs
in constant supply prices), we have to deal with
an all-inclusive index that also reflects the extent to which materials are economized. If, for
example, a saving in materials occurs while
gross output remains constant, this type of net
output will record a certain increase. The other
two methods, on the other hand, are neutral with
respect to savings of materials. This is sometimes considered a defect of the first method,
since that index fails to measure trends in output
(in the usual sense). These characteristics of
the first method may be regarded as an advantage rather than a disadvantage, since it is now
possibly more important, and at least not less
important, to economize materials than to force
an increase in output.
This method has its defects, e.g., it is less
neutral with respect to assortment (product mix)
than the other methods, since it is difficult to assume that profit margins in factory prices will
remain unchanged even when those prices have
been altered in the manner described above.
I shall not try to decide here which of these
three methods is the best. Undoubtedly this depends to a great extent on the given branch. I
should merely like to recall that the first method
(that of subtracting the costs of materials used,
at constant prices, from gross output, in con-

stant factory prices) converges, with respect to

corrections in the wage fund, with the proposal
contained in the report of the commission for
testing indices of industrial production (under
the chairmanship of Comrade Blinowski). In particular, this report proposes to relate total or
market output to the sum total of material and
wage costs and not to the corrected wage funds.
For the purpose of correcting the wage fund, the
device of converting economies of materials into
increases in the wage funds is basically identical
with the use of net output of the first type, which
reflects savings of materials. It should be added
that the synthetic nature of the last index is a
major argument for its use in the form of the
main directive index.
3. Product quality control. One last point. I
should like to stress that all the ideas advanced
here for improving the system of incentives are
only meaningful if the methods of quality control
are improved. If such control does not take
place, then the enterprise is better off the worse
the quality of its products is, no matter who runs
the firm.
The first index of net output, which promotes
the desired economy of materials, is also the
most defective when adequate controls are lacking. It will result in fictitious savings of materials, achieved by lower quality.
This also applies to the question of labor saving of all sorts, since an apparently high productivity is attained by producing low-grade articles
in the absence of proper controls.
The use of effective incentives thus calls for
an effective quality control; at this point we are
far removed from a buyer's market where the
function of quality control can be performed by
the purchaser. Even in this case quality control
by consumers may indeed be deceptive, since
repeated defects in an article may be identified
only after it has been used for a long time (as is
the case with machinery and related products).
To sum up, quality control in all enterprises,
regardless of the system of management, is a
condition for correct functioning of any system
of incentives.

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