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The Other (Better) Approach to Economic Growth

by daneca Wed Mar 5th, 2008 at 06:05:12 AM EST

Traditional economic growth models suggest (assert) that investment (capital) drives economic growth. Hence, under the investment = growth paradigm, public policies favor capital and wealth accumulation (the argument is that supply creates demand). Redistribution is an issue because the promised "trickle down" is either too slow, at best, or has not materialized. But, is it really possible to redistribute under this paradigm?

Promoted by afew

In a recent commentary on The Debt Delusion, Thomas Palley criticizes one the foundations of this approach thusly:

...The new cycle rests on financial booms and cheap imports. Financial booms provide collateral that supports debt-financed spending. Borrowing is also supported by an easing of credit standards and new financial products that increase leverage and widen the range of assets that can be borrowed against. Cheap imports ameliorate the effects of wage stagnation.

This structure contrasts with the pre-1980 business cycle, which rested on wage growth tied to productivity growth and full employment. Wage growth, rather than borrowing and financial booms, fuelled demand growth. That encouraged investment spending, which in turn drove productivity gains and output growth.

Palley concludes that...

It is not enough to deal only with the crisis of the day. Policy must also chart a stable long-term course, which implies the need to reconsider the paradigm of the past 25 years. That means ending trade deficits that drain spending and jobs, and restoring the link between wages and productivity. That way, wage income, not debt and asset price inflation, can again provide the engine of demand growth. (my emphasis)

Of course, IMO this is "intuitively and morally right". But I've never seen an explicit economic expression that links growth, productivity and wage income. Although most recent development policies stress the need for productivity gains in poor countries, the "recipes" remain centered in attracting foreign investment, labor market liberalization, educational reform, ICT's, governance, institution building, etc. etc. In fact, cheap labor is praised as the poor countries' "competitive advantage".

Some 20 years ago, facing the reality of increasing numbers of poor people and the widening income gap en Latin America, it was clear to me that growth is not really the issue; who benefits from growth, is. Although I am not an Economist, my several years of "microeconomic experience" as an entrepreneur in a small chemical industry also showed me that the economic growth models -with all the math-juggling around the Production Functions- did not quite square with my experience of wealth creation in my small business.

At the "micro level", wealth is created transforming a given set of primary goods into final products of higher value. The Value Added (VA) in the process is the retribution to the various inputs: labor, capital, fixed assets, public services, etc.  The "Per Capita Income" -the payroll (W) divided by the number of workers (PO), or mean wage-, is the fraction of the Value Added destined to the payroll (W/VA), times the Labor Productivity (PL):

MW = W/PO = (W/VA)*(VA/PO) = W/VA * PL     (1)

Since the GDPpc is the product of the Labor Productivity times the fraction of working to total population [GDPpc = PL * (PO/PT)], from (1) we get:

GDPpc = (VA/W) * MW * (PO/PT)        (2)

Equation 2 means that GDPpc equals the ratio of VA to payroll ("Wage Productivity"), times the "mean wage", times the fraction of working to total population. Therefore, growth is directly proportional to VA and to the "mean wage" (buying power!); implies that for sustainable growth, gains in productivity must be reflected in higher salaries. This is the defining characteristic of all "good" growth episodes.

This "finding" reflects Marriner Eccles' explanation of the origins of the Great Depression:

"As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -not of existing wealth, but of wealth as it is currently produced- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery" (my emphasis)

In post-cold war capitalism, wealth concentration has become "the virtue". As recent diaries and comments have pointed out, the roots of the crony and casino capitalism (casinotalism) that creates the market bubbles, real state speculation, etc., can be traced back to this concentration of wealth. Effective redistribution under this "free-market" is clearly impossible.

As a side comment, is worth noting that since MW and (PO/PT) are nearly constant in the short run (relation 2), the smaller W is with respect to VA (typical of K-intensive processes, common to the Dutch and the Anglo diseases), the stronger will be: a) the influence of changes in VA in the GDP growth rates; and b) the skewedness of the GDPPC distribution.

In closing, the claim that capital is the driving force for growth is not quite true. Actually, there are several factors (other than capital) that may lead to increasing Value Added in a given economic setting. Furthermore, although capital (investment) may be needed to (re)create wealth, it is as important (if not more) to ensure that labor and capital inputs lead to higher Value Added and to higher (productivity-based) salaries and wage income (MW). Redistribution as wealth is created is the key for sustainable growth; wages closely pegged to productivity gains, is the most efficient and cost effective redistribution mechanism.

Although these relations are very straightforward, show the other -and better- side of growth, and have important implications for public policy, they are never part of the economic analysis and debate. Why?

As others have pointed out, even henry ford recognised that he had to pay his workers well enough to be able to afford to buy his cars.

And, as I know J never tires of pointing out, the big elephant here is that wages are considered a cost to be minimised and allowing wealth-capture to be concentrated at the CEO level. An awful lot of self-deluding economic theory has grown up around justifying that fallacy.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 3rd, 2008 at 03:02:23 PM EST
... endogenous growth theory (not to be confused with New Keynesian endogenous growth theory (1)) from the ground up.

Most of this is in academic journals, so sitting behind a subscription firewall for most people, but the first page of Chris Niggle's Evolutionary Keynesianism: A Synthesis of Institutionalist and Post Keynesian Macroeconomics gives a hint.

(1. In New Keynesian economics, contra Keynes, in the Long Run we are all Neoclassicals.)

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Mar 3rd, 2008 at 07:17:41 PM EST
... the reason you are discovering this part of Post Keynesian economics is because they originally found it by looking at the economy, so its there to be rediscovered by other people who look at the economy.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Fri Mar 7th, 2008 at 12:46:10 AM EST
[ Parent ]
Years ago, we had to work to produce necessary things. Now we have to produce superfluous junk to keep ourselves working. But this makes no sense when the human race as a whole appears to be using up resources at an unsustainable pace. Has "labour productivity" gone too far?

ANGUS SIBLEY, website http://www.equilibrium-economicum.net, "Querying economic orthodoxy"
by parisien on Wed Mar 5th, 2008 at 05:02:14 AM EST
Years ago, we had to work to produce necessary things. Now we have to produce superfluous junk to keep ourselves working.

welcome, parisien!

that's about the wryest, aptest summation of the human condition i've enjoyed in a while.

consumerism is simply madness writ large, the most idiotic delusion the species has ever shot itself in the foot with.

foot, magari, more like the frontal cortex!

poor humans gonna have to reboot the whole system. money was such a convenient tool/invention, but as we see now, it is the mother of all two-edged swords. if we're not mature enough to use it with extreme care, then abused, it will cut us to shreds, and it's back to barter.

slow or fast, hard or smooth, this top heavy artifice we call 'society' is going down, and in 5 years will possibly be as unrecognisable as today's would be to a caveman.

<disclaimer> feeling this way since '75! wrong then, probably wrong now, but just can't shake the gut feeling anyway.

playing the blues, playing the blues, it's the only thing that gives me faith to smile through the tears, or cry through the laughter.

oy yes, and  this...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Wed Mar 5th, 2008 at 07:29:05 AM EST
[ Parent ]
Welcome, daneca.

this is "intuitively and morally right".

It certainly sounds a lot more livable for the great majority, whosever theory it is, although I still cannot see clearly through the word ´growth´ at this point.

Our knowledge has surpassed our wisdom. -Charu Saxena.

by metavision on Thu Mar 6th, 2008 at 03:02:30 PM EST

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