Development by invitation: a short digression on the concept

 

Development? Be my guest 

The concept of development by invitation, as far as I know, and most of my knowledge comes from Esteban Pérez's paper in a book we co-edited long ago,  originates with Arthur Lewis and refers to a development strategy in which small developing economies attract foreign capital to initiate industrialization. For Lewis, the problem of many small developing economies, particularly in the Caribbean, was that they lacked several key elements required for industrialization, namely: domestic capital, entrepreneurial skills and large domestic markets. Because of these constraints, industrialization could not easily emerge through domestic investment alone. Lewis therefore proposed industrialization by invitation, meaning that governments should invite foreign firms to establish manufacturing activities in the country.

Immanuel Wallerstein refers to a path of development in which a peripheral country advances economically because the multinational corporations from central countries actively expand into the world economy. This development occurred not through autonomous national transformation, but through external investment resulting from political and economic cooperation with central countries. For Wallerstein, the concept referred to a structural process within the capitalist world-system. In his framework, central countries allowed limited industrialization in some peripheral areas as multinational firms relocated production. That was, in fact, to some extent the phenomenon in a good part of the Latin American periphery, In other words, development by invitation was not a development policy, but a mechanism of global capitalism that reorganized production.

In the work of Carlos Medeiros (published with Franklin Serrano; he is pictured above), the notion of development by invitation refers to a historical process in which peripheral or late-industrializing countries accelerate their development because the leading powers of the international system actively support or tolerate their industrialization for geopolitical reasons. The concept is embedded in their analysis of international monetary regimes and growth dynamics. Growth is demand-led, and based on the supermultiplier, if that wasn't clear.

For Medeiros, the starting point is that capitalism naturally generates divergence between countries due to structural asymmetries in military power, technological capabilities, and monetary hegemony. All three are interrelated. Because of these asymmetries, most peripheral countries face a balance-of-payments constraint that limits growth. However, in certain historical periods, some countries can overcome these constraints when the dominant power facilitates their development.

For Medeiros,  development is not simply the relocation of production associated to multinational or transnational firms, be that as a policy strategy or an endogenous process of integration within the capitalist system. It involves state-led industrialization and strategic geopolitical support from the hegemonic power. Hence, development by invitation can produce successful industrial catch-up, not merely integration into the world economy.

Note that Esteban's discussion implicitly highlights a critique of the early concept from a structuralist perspective. Even though Lewis viewed the strategy as a path to development, in practice it often led to enclave industrialization and persistent dependence on multinational firms. The outcome sometimes resembled the type of dependent integration emphasized by Wallerstein. In a sense, Medeiros version is a further critique, suggesting that the interaction of political coalitions, behind the developmental state, and the geopolitical context matter.

Note that one might be correctly skeptical  of the notion that a country develops simply because the hegemonic power invites it to do so. Even acknowledging that favorable geopolitical contexts existed, such as those of Japan, South Korea, or several European countries in the postwar period, one might argue that development was ultimately the result of internal strategies, that is, strong states pursuing active industrial policies of technological catch up. In this view, the invitation may have constituted a favorable external framework, but it was never the decisive factor.

However, this critique appears to address a somewhat simplified interpretation of Medeiros’ concept. In his framework, development by invitation was never presented as a purely external process or as a microeconomic explanation based on private decisions. The concept was formulated in macroeconomic and geopolitical terms, placing emphasis precisely on the role of the state. The question was not whether Japan or Korea developed simply because the United States invited them, but rather why certain developmental states were able to industrialize so rapidly through manufactured exports. The answer highlights that these states benefited from exceptional external conditions. First, the unilateral opening of the US market, financial transfers,  very often facilitated technological transfers, beyond tolerance toward aggressive industrial policies, and strategic support within the context of the Cold War. This was not diplomatic magic, but rather a combination of an internal developmental state and a relaxation of the external constraint facilitated by American hegemony.

In other words, Medeiros’ concept does not attempt to explain development exclusively through external factors, but rather to illuminate why certain developmental states faced fewer external constraints, had greater access to financing, and enjoyed broader access to strategic markets than others. This allowed for a particular mix of export promotion and import substitution and helps explain why several Asian countries not only avoided the lost decade that followed the debt crisis of the 1980s, but also managed to accelerate their process of industrialization as a good part of the center, and other peripheral regions deindustrialized.

If the discussion is brought to the current Argentine case (I wrote a short note on this in Spanish), the most important point may not be to deny the relevance of the concept but to recognize that Argentina today lacks a developmental state capable of taking advantage of any potential invitation. If the government dismantles industrial, technological, and financial policy instruments, then whether a country is invited or not becomes almost irrelevant. The issue is not whether Washington extends a diplomatic invitation, but whether there exists a national strategy capable of transforming a favorable geopolitical context into productive accumulation.

Ultimately, the debate should not revolve around whether development arrives mechanically by invitation, but rather around the interaction between internal state strategy and external conditions. Development has never been automatic or purely external, but neither has it been independent of the geopolitical order and the decisions of the hegemonic power.

Policy Parlor with Franklin Serrano

My conversation with Franklin during his visit to Bucknell University. We talked about the supermultiplier and its applications to understanding real economies. The quality of the sound is better than I had expected, even if the camera is moving somewhat, and could be distracting.

Book Presentation “India from Latin America. Peripherisation, Statebuilding, and Demand-Led Growth” by Manuel Gonzalo

A demand-led growth perspective of Indian development. Book available here. Comments by Alex Thomas.

Cycles: empirics and the supermultiplier theory

 

New paper on the empirical evidence of the relevance of the supermultiplier for explaining economic cycles by Ricardo Summa, Gabriel Petrini, and Lucas Teixeira. From the abstract:

The demand-led supermultiplier growth model proposes that business investment is induced by income while autonomous expenditures determine economic growth. The most known versions of the model are presented at high levels of abstraction, focusing on general analytical properties and dynamic stability conditions. Based on those versions, Nikiforos et al. (2021) argue that the supermultiplier model cannot generate business cycles compatible with the empirical observation. In this paper, we show that this conclusion is a consequence of the misspecification of the variable chosen to represent the investment share, which includes business and residential investment. As the separation of those expenditures is a central point in the supermultiplier theory, we estimate a VAR model for the US economy (1967-2020) using only the data on business investment share instead. This procedure re-establishes an important feature to the supermultiplier theory, the mechanism of capital stock adjustment, as the empirical results points to the business investment share generally lagging the cycle. Finally, we make some remarks on how to discuss the business cycle from the supermultiplier perspective. We argue that for the supermultiplier, the business cycle depends less on the mechanism of capital stock adjustment than on the behavior of the autonomous components of demand and changes in the multiplier components. As the latter two are influenced by political, social and institutional factors, each business cycle has its own narrative.

Download here.

Autonomous demand, capacity utilization, and the supermultiplier

New issue of ROKE is out. Check out the free papers by Serrano, Summa and Garrido Moreira, and by Fiebiger, beyond the intro by Summa and Freitas.

Investment Rate, Growth and Accelerator Effect in the Supermultiplier Model: the case of Brazil

A new paper by Julia Braga, that she will present at the next Eastern Association Economic Meeting in Boston. From the abstract:

"This paper investigates the role of demand in the productive investment evolution in the Brazilian economy. First, it assesses the long-run relationship between investment rate and GDP growth, taking annual data since 1962 until 2015. We then construct a “Final Demand” index and estimate its impact on productive investment growth rate, taking quarterly data since 1996q1 until 2017q2, highlighting a shift in the aftermath of the 2008 world economic crisis. The results support two hypotheses of the Supermultiplier model of Freitas and Serrano (2015) and Serrano, Freitas and Behring (2017) for the Brazilian economy: 1) non-capacity creating expenditures lead productive investment; 2) there is a very slow adjustment of the investment rate to demand growth, as described by the flexible accelerator process."

Read full paper here.

Beyond the traditional monetary circuit

Slow posting will continue the rest of the Summer. Here a paper by Sergio Cesaratto that might be of interest. From the abstract:

The paper is a contribution to a long-run theory of effective demand with elements from monetary circuit theory, Modern Monetary Theory and endogenous finance analysis. Some shortcomings of the still influential neo-Kaleckian growth model and monetary circuit theory are underlined, and the Sraffian supermultiplier is indicated as the most promising heterodox approach to growth and instability in capitalism. The Sraffian supermultiplier allows full consideration of the autonomous components of aggregate demand as the ultimate sources of growth and instability in modern capitalism. Following Steindl, capital gains are included among these components. Autonomous demand and investment are typically fed by endogenous finance. The paper articulates the relation between autonomous demand and investment on one hand, and endogenous finance on the other, in the light of Keynes’s distinction between initial and final finance.

Read rest here.

A Brief Sketch of the Classical-Keynesian Perspective

By David Fields

From a Classical-Keynesian perspective (Bortis, 1997, 2003), rates of interest regulate rates of profits (Panico, 1980, 1985), and, thus, real wages are endogenously determined. The presence of financial instruments, which represent titles to future flows of income, makes it so that the actual center of distributive conflict in capitalism lies not in the technical conditions of production, but is rather governed by the real rate of interest, which is a conventionally-determined exogenous variable that reflects the relative powers of finance capitalists vis-à-vis industrial capitalists & labour (Pivetti, 1985, 1991, 2001).

The rate of profit, as a ratio, has a significance, which is independent of any prices, and can well be ‘given’ before the prices are fixed. It is accordingly susceptible of being determined from outside the system of production, in particular by the level of money rates of interest. (Sraffa, 1960: 33)

In this sense, high real rates of interests induce industrial capitalists to prefer short-term speculative financial investment, instead of long-term productive real investment, since access to credit is expensive. Consequentially, industrial capitalists center attention on the pursuit of immediate surplus value realization, via speculation, in order to handle the burden of costly interest payments—the social cost being nominal wage suppression, which, by implication, exhibits an enlargement of the reserve army of labour.

[…] the credit system, which has its focus in the so-called national banks and the big money-lenders and usurers surrounding them, constitutes enormous centralisation, and gives this class of parasites the fabulous power, not only to periodically despoil industrial capitalists, but also to interfere in actual production in a most dangerous manner— and this gang knows nothing about production and has nothing to do with it. (Marx 1894: 544-45)

Along these lines, heterodox growth and distribution models have been put forward (cf. Hein, 2008), highlighting the need for a redistribution of income from finance/industrial capitalists to labour (Lavoie and Seccareccia, 1999) and making unemployment the primary policy target (Smithin, 2004). Underpinning these models are works that incorporate Keynes’ principle of effective demand and Sraffian price theory in a long-period analysis of capital accumulation (Park, n.d.; Cesaratto et al. 2003). These studies pay considerable attention to the extent to which the Hicksian supermultiplier concept effectively explicates the degree to which induced consumption and investment, via the accelerator, determine average levels of total output (Serrano, 1995) and, thus, normal capacity utilization (Amadeo, 1986; Trezzini, 1998), with the richness of a framework inspired by Kaldor and Pasinetti (Docherty, 2012) that meticulously constitutes the palpability of Kalecki’s famous aphorism that ‘capitalists get what they spend…workers spend what they get’.

Originally published in the URPE blog.

References:

Amadeo, Edward J. 1986. “Notes on Capacity Utilisation, Distribution and Accumulation.” Contributions to Political Economy 5(1):83–94.

Bortis, Heinrich. 1997. Institutions, Behaviour and Economic Theory: A Contribution to Classical-Keynesian Political Economy. Cambridge: Cambridge University Press.

Bortis, Heinrich. 2003. “Keynes and the Classics: Notes on the Monetary Theory of Production.” In Modern Theories of Money: The Nature and Role of Money in Capitalist Economies, (eds.) Louis-Philippe Rochon and Sergio Rossi. Cheltenham, UK: Edward Elgar.

Cesaratto, Sergio, Franklin Serrano, and Antonella Stirati. 2003. “Technical Change, Effective Demand and Employment.” Review of Political Economy 15(1):33.

Docherty, Peter. 2012. “Long Period Interest Rate Rules in a Demand-Led Kaldor-Pasinetti-Sraffa-Keynes Growth Model.” Journal of Post Keynesian Economics 34(3):521–46.

Hein, Eckhard. 2008. Money, Distribution Conflict and Capital Accumulation: Contributions to 'Monetary Analysis'. Basingstoke: Palgrave Macmillan.

Kalecki, Michal. 1971. Selected Essays on The Dynamics of the Capitalist Economy 1933-1970. Cambridge: Cambridge University Press

Kaldor, Nicholas. 1955. “Alternative Theories of Distribution.” The Review of Economic Studies 23(2):83–100.

Kaldor, Nicholas. 1966. “Marginal Productivity and the Macro-Economic Theories of Distribution: Comment on Samuelson and Modigliani.” The Review of Economic Studies 33(4):309–19.

Lavoie, Marc, and Seccareccia, Mario. 1999. “Interest Rate—Fair.” In Encyclopedia of Political Economy, vol. 1, (ed.) Phillip Anthony O’Hara. London: Routledge.

Marx, Karl. 1894. Capital Vol. III. New York: International Publishers.

Panico, Carlo. 1980. “Marx’s Analysis of the Relationship between the Rate of Interest and the Rate of Profits.” Cambridge Journal of Economics 4(4):363–78.

Panico, Carlo. 1985. “Market Forces and the Relation between the Rates of Interest and Profits.” Contributions to Political Economy 4(1):37–60.

Park, Man-Seop. n.d. “Towards a ‘Classical-Keynesian’ analysis of Effective Demand in the Long Period.” Retrieved May 8, 2014.

Pasinetti, Luigi L. 1962. “Rate of Profit and Income Distribution in Relation to the Rate of Economic Growth.” The Review of Economic Studies 29(4):267–79.

Pasinetti, Luigi L. 1974. Income Distribution and Growth. Cambridge: Cambridge University Press

Pivetti, Massimo. 1985. “On the Monetary Explanation of Distribution.” Political Economy: Studies in the Suplus Approach 1(2):73–104.

Pivetti, Massimo. 1991. An Essay on Money and Distribution. London: Macmillan.

Pivetti, Massimo. 2001. “Money Endogeneity and Monetary Non-Neutrality: A Sraffian Perspective.” In Credit, Interest Rates and the Open Economy, (eds.) Louis-Philippe Rochon and Matias Vernengo. Cheltenham, U.K: Edward Elgar.

Serrano, Franklin. 1995. “Long Period Effective Demand and the Sraffian Supermultiplier.” Contributions to Political Economy 14(1):67–90.

Smithin, John. 2004. “Interest Rate Operating Procedures and Income Distribution.” In Central Banking and the Modern World, (eds.) Marc Lavoie and Mario Seccareccia. Cheltenham, UK: Edward Elgar.

Sraffa, Piero. 1960. Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press.

Trezzini, Attilio. 1998. “Capacity Utilisation in the Long Run: Some Further Considerations.” Contributions to Political Economy 17(1):53–67.

A Clarification of the clarification of supermultipliers

After my post I got an email and post below by Franklin. Mind you, I still would refer to supermultiplier models as Kaldorian, and the models with autonomous investment as neo-Kaleckian. As Franklin notes Bortis, a Kaldorian and Sraffian, makes the transition to exogenous distribution, even if Kaldor himself didn't. Below the email and the post.

Dear Matias:

Great Post.Your use of the phrase “no independent investment function” to refer to induced investment models is unfortunately quite confusing.

This phrase since the classic survey of Hahn in Matthews has been used to refer to models in which full employment (or full capacity in Lewisian and neo-Marxian models) saving determines investment.

I am sure that what you mean is that in supermultiplier models there is no autonomous component in the (capacity creating) investment function. It would be much better to all of us if you changed that at no cost for you. If you do this , please omit this part from my uninvited guest post.
...

The Sraffian supermultiplier (Serrano, 1995) , as the name says is,well... Sraffian. That means that its key feature is that distribution is exogenous. In fact the original title of my 1995 PhD dissertation was going to be “demand led capacity growth under exogenous distribution”. That is why it can and recently it has been adopted/discovered by a few eminent neo-Kaleckians , as the key feature of their approach is also the exogenous profit share, determined separately from output (although along different lines through the degree of monopoly).

Kaldor himself never moved away completely from some version of the Cambridge theory of distribution, either of the “competitive” (prices are flexible relative to Money wages ) or “managerial” (there is mark-up pricing but the mark-up is function of the desired induced investment share and thus of the rate of growth of the economy (a la Wood, Eichner, etc.) . See chapter three of my PhD thesis and chapter two of my 1988 Master´s thesis for a critique of both [in Portuguese].

In both (totally unrealistic )versions of the Cambridge mechanism, it is accumulation that determines distribution endogenously, unlike the separation between distribution and accumulation we find in Sraffa , Kalecki and their modern followers.

In fact, Kaldor´s paper that I quoted in my thesis and that Lavoie (2015) mentions, called “conflict in national economic objectives” is the only one in which (although without using equations) he does not mix the harrod balance of payment equilibrium condition X/m=Ybp ,which shows a balance of payments constraint with a proper supermultiplier , say Y=G+X/(c(1-t)+m-gv ) which is the level of output determined by effective demand

In all his other works Kaldor makes Y=Ybp and this occurs because Kaldor arbitrarily assumes that G=t.Y and that vg =(1- c(1-t)) via some Cambridge mechanism that makes the aggregate marginal propensity to consume adjust itself to the marginal propensity to invest vg. See Fabio Freitas (2003) and Bhering & Serrano (2013) for details here and here.

(Palumbo ROPE 2009 also mentions these assumptions by Kaldor but unfortunately fails to note that the endogeneity of distribution that is the problem and not the induced investment function as she claims)

The inconsistency of having a proper aggregate demand led growth model with endogenous Cambridge distribution is the reason why I say in chapter two of my Ph. D. thesis that “It seems then that the only reason why Kaldor did not get to point of producing a explicit model of the industrial economy identical to our Sraffian supermultiplier must be attributed to

His reluctance to abandon completely his own version of the Cambridge theory of distribution. In fact , a consistent supermultiplier analysis requires the distribution of income  (and the aggregate marginal propensity to save) to be treated as an exogenous parameter, being therefore incompatible with the idea that distribution is somehow endogenously determined via the Cambridge equation.”

And it is then also no surprise that it was Heinrich Bortis, supervised by Kaldor that first got to the idea of an exogenous distribution supermultiplier, that he calls “Classical-Keynesian” in his 1979 Cambridge PhD (though his book was published only in 1997).

But note that , again as I demonstrated in chapter 3 of thesis, that in Cambridge models whatever the initial level of capacity there will always be enough aggregate demand for as distribution will change so that aggregate consumption changes to fill the gap (see Serrano & Freitas, 2015).

Of course you may ask: but then what is the point of having induced investment growing at the rate the autonomous part of demand grows if there is never lack of aggregate demand? The only consistent answer to this last question is: please just drop the endogenous distribution Kaldorian supermultiplier and use either the neo-Kaleckian or Sraffian ones, according to the theory of exogenous distribution you find more reasonable. In other words, if you like the idea of an autonomous demand supermultiplier , don´t be Kaldorian (in this specific sense). The exogenous distribution supermultipliers are not just more general as Vernengo correctly argues but most importantly , they are more consistent.

Kaldorian and Sraffian supermultipliers: a clarification

This is a post for those interested in demand-led theories of growth. Not long ago I wrote a post on misconceptions about Sraffian economics. Marc Lavoie sent me a nice email about it, and a recent paper he published in Metroeconomica (subscription required), which comments on a paper I wrote with Esteban Pérez (working paper available here). In his discussion of supermultiplier models, which put the multiplier and the accelerator together to explain -- not fluctuations of the level of output around its normal position -- but the determination of trend or normal output. Lavoie says:

"Other post-Keynesians, also assume that non-capacity creating autonomous expenditures are the driving force, rather than investment. Serrano himself refers to Kaldor (1983, p. 9) to provide support for this reversal of causality. Fazzari et al. (2013) assume that there is some unidentified demand component that grows autonomously, in order to tame Harrodian instability; Godley and Lavoie (2007, ch. 11) and, as already pointed out Allain (2015), rely on autonomous government expenditures. Indeed, there is a large Kaldorian literature that relies on exogenous growth components other than business investment, most particularly the whole literature on Thirlwall 's law with its exogenous exports (McCombie and Thirlwall, 1994), as well as Godley and Cripps (1983), with both government expenditure and export sales."

And in a footonte to that passage he says:

"Thus, adding to the confusion over terminology, Pérez-Caldentey and Vernengo (2013) refer to the Kaldorian tradition when discussing models based on induced investment and non-capacity creating exogenous growth components such as Serrano's Sraffian supermultiplier analysis."

So let me clarify our use of Kaldorian, and also why I believe that it is a mistake to refer to the Sraffian supermultiplier as neo-Kaleckian, even though it does have evidently Kaleckian elements. As I understand the distinction that came to dominate demand-led models of growth, there are basically two* main traditions, one that is referred to as neo-Kaleckian, and one that is referred to as Kaldorian.

The first tradition developed from Bob Rowthorn's expansion of Joan Robinson's 1960s model. And because Joan Robinson was influenced by Kalecki, and  Rowthorn, a Marxist author, was seen as Kaleckian, the name stuck. The original model, one must note was wage-led. And causality basically determined whether the authors was Keynesian or Marxist, with Ed Nell famously referring to one author that suggested that causality went from income distribution to growth as Jean Baptiste Marglin. At any rate, Marxist and Keynesian closures, to use the term popularized in this context by Lance Taylor, were special cases of the neo-Kaleckian model. Later developments introduced changes in the independent investment function which allowed for a profit-led closure.

As I noted before, the term Kaleckian is a bit of a misnomer. The current version of the model allows for a profit-led closure, which is not clearly in Kalecki, and, besides its derived from Joan Robinson's model. The Kaleckian feature is that often it is assumed that workers do not save, and capitalists do not consume, for simplification, a classical political economy type of assumption really.**

The genesis of supermultiplier models is more convoluted. On the one hand, the combination of multiplier and accelerator was used to discuss economic cycles, not growth, including by Hicks, who first discussed the idea of the supermultiplier. By the late 1960s, Kaldor moved away from the differential savings or neo-Keynesian growth models (sometimes referred to as Kaldor-Pasinetti or Cambridge growth model), and adopted the supermultiplier model, formalized by Thirlwall in the 1970s. The model assumed as a simplification that exports were the only autonomous component of demand. In accordance with the accelerator, investment was seen as derived demand. That is the main difference with the so-called Neo-Kaleckian models, namely: there is no independent investment function.***

The idea of the supermultiplier was later, in the 1980s and 1990s, developed by Bortis and Serrano,**** both authors sharing a Sraffian perspective. In these versions, autonomous spending was not restricted to exports, and government spending was also relevant. The term Sraffian or classical-Keynesian has been used to describe these models. In essence, they are Kaldorian models, since investment is derived demand, as much as in Thirlwall's model. In this sense, even though the Kaldorian models a la Thirlwall are a special case of the Sraffian supermultiplier, as discussed here in my debate with Jaime Ros (in Spanish), and by definition more general than the export-led growth model, they came later, and can be seen as a development within this tradition.

So certainly the intention is not to create confusion. In my view, models with an independent investment function are broadly speaking neo-Kaleckian, while models in which investment is derived demand are Kaldorian. And there are differences between models within those broadly defined traditions.

* All taxonomies are somewhat arbitrary and one might see some sub-divisions from the two main branches discussed here as standing in the same footing, for example, some might argue for an explicitly Marxist tradition.

** Goodwin predator-prey models, which have become quite fashionable, can be seen as a variation of these neo-Kaleckian models.

*** I think these Cambridge models have been completely abandoned since the 1960s, and that is the reason why I don't have three types of models in my taxonomy. They are a historical curiosity, associated to a response to the Harrod instability problem, at a time when full employment seemed like a stylized fact in advanced capitalist economies. For a clear explanation of the implications of the different model closures see the paper by Franklin Serrano and Fabio Freitas here.

**** The Sraffian versions of the supermultiplier model also assume differential savings by workers and capitalists, as many other classical political economy inspired models, and in that sense have Kaleckain features. But they are not neo-Kaleckian, since there is no independent investment function.

Thirlwall's Law debate in Investigación Económica

 

The other side

Jaime Ros, with Pedro Hugo Clavijo, wrote a critique of Thirlwall's Law (in Spanish). Replies by Carlos Ibarra here, Esteban Pérez here and myself here. Their rejoinder here. All in Spanish. Haven't read the whole rejoinder yet (just got it), but for some reason they insist that the supermultiplier implies that exports are always the main source of autonomous demand.* Hm, that's weird. Just puzzled by that one. They should read Bortis and Serrano (this one with Fabio Freitas). Oh well.

* In their words: "El problema con esta propuesta [el supermultiplicador], ... implícitamente está suponiendo que las exportaciones son el componente principal, aunque no único, de la demanda autónoma..." Translation: "The problem with this proposal [the supermultiplier],... is that implicitly presumes that exports are the main component, even if not the only one, of autonomous demand..."

Gets better. They agree with me on this. In their words:  "estamos de acuerdo con Vernengo cuando dice: '(…) el modelo de Thirlwall no es capaz de captar la complejidad del proceso de desarrollo asiático, el papel del Estado, de la inversión pública, del financiamiento de los bancos públicos, del papel jugado por factores geopolíticos asociados a la amenaza comunista, entre otras cosas'." Translation: "we agree with Vernengo when he says: '... Thirlwall's model is not capable of explaining the complexity of the Asian development process, the role of the State, of public investment, of public banks' financing, of the role played by geopolitical factors associated with the communist threat, among other things'." The rest of the paragraph they forgot to quote: "Several of these factors were operative through autonomous government spending. One cannot think about the Chinese case without public investment." That would be as in government spending is the main, even if not the only, source of autonomous demand.

PS: The whole issue of Investigación Económica is available here.

Notes on the Policy Implications of the New Macroeconomic Consensus

The New Macroeconomic Consensus (NMC) model is based on three simple equations. An IS equation that, contrary to what most discussions within the heterodoxy suggest, is based on a Ramsey model intertemporal approach to savings and investment, a Phillips curve (PC) equation, normally with rational expectations, and a monetary policy (MP) rule, typically Taylor’s rule. From the IS and the MP an aggregate demand (AD) curve is derived, while the PC provides an aggregate supply (AS) curve, similar to Lucas’ supply curve. Business cycles are seen as being determined by shocks, either monetary, that affect the AD curve, or real, which impact the AS curve.

A few things are important to note with respect to the NMC model. First, the IS curve now is not based on the traditional Keynesian multiplier process, by which savings adjust to investment (or in more sophisticated models with endogenous investment, to autonomous demand) as a result of variations to the income level. Agents make intertemporal decisions on consumption and savings, and investment adjusts, in the absence of imperfections, to full employment savings as in the pre-Keynesian models. That is the reason why in order to stimulate the economy it is often suggested that what is needed is higher inflationary expectations (which in this framework could be caused by the central bank announcing a higher inflation target), which would in turn lead to an increase in current consumption (since inflation would reduce future consumption possibilities; see my critique of this view, which I refer to as the inflation expectations fairy, here).

Second, both the New Keynesian Phillips Curve and the Taylor rule presuppose the existence of a natural rate of unemployment, in line with Milton Friedman. Further, stabilizing the rate of inflation around its target is tantamount to stabilizing output around its full employment level, a result sometimes referred to as the ‘Divine Coincidence.’ Thus, inflation is always the result of a level of unemployment that is below its natural level, or in other words caused by demand-pull. Supply-side shocks may eventually cause inflation too, but those are seen, at least by most New Keynesians as being of secondary importance. Even Lucas, who has accepted for the most part the Real Business Cycle story, admits that one cannot explain the Great Depression and other such crises with real shocks.

Third, the MP rule implies that money is endogenous, and that central banks control the rate of interest and NOT the quantity of money. In other words, the old Monetarist rules about the rate of growth of money supply are out, since actual central banks very rarely have behaved in that way. This ‘innovation’ (not much of an invention since Wicksell used more than a century ago) within the mainstream took place without ever acknowledging the contributions of Kaldor (accomodationist tradition to endogenous money), Minsky (financial innovation tradition to endogenous money), Moore and other post-Keynesian authors.

Finally, it is rather clear that the NMC is essentially a neo-Wicksellian model (for a simple description go here), rather than Keynesian (New or otherwise). Not only the multiplier model was abandoned (and with it even the basis for fiscal policy activism, since the logic of Barro’s Ricardian Equivalence has been incorporated; see Wren-Lewis here), but also the concept of the natural rate that Keynes at least tried to get rid of has become central for policy analysis. And here is the Achilles’ heel of the NMC model.

Note that if the natural rate is not fixed, and in particular if it presents hysteresis or path dependence, and moves with the actual level of unemployment, then the basis of the NMC model falls apart. In other words, expanding demand might reduce the natural rate of unemployment and would not trigger inflation, and as a result would not require the central bank to hike the rate of interest to lean against the wind. That was, in a sense, the rationale for not hiking the rate of interest when unemployment fell below 6%, which many identified as the natural rate, during the Clinton boom. Greenspan suggested that productivity was going up (note that he didn’t necessarily say that productivity went up, and the natural rate down, as a result of the expansion of demand).

There are good logical reasons for not believing the natural rate story, as we know, associated to the limitations of the marginalist theory (see here). However, there are also reasonably well-established empirical problems with the natural rate hypothesis. The Real Business Cycles authors, in particular Nelson and Plosser in their classic paper (here), have long ago shown that output follows a random walk. In other words, changes in output are permanent, and there is no tendency for output to revert to its former trend following a shock, contradicting the natural rate hypothesis, or suggesting if one prefers that the natural rate moves with supply-side shocks and that the business cycle is the result of agents adjusting their behavior to the change in the natural rate.

As I noted before (here), the actual measure of productivity (Total Factor Productivity, TFP) used by RBC authors does NOT measure productivity, and most of their conclusions are irrelevant really. Also, as suggested above, it would be impossible to pin down the real shock that caused the Great Depression or the Great Recession, that have structural causes that are profound (in the patterns of consumption, private indebtedness and inequality) and that were triggered by financial shocks. However, the notion that the natural rate is not fixed, and that it changes significantly is actually quite important, since as we indicated, it suggests that policies that try to lean against the wind hiking the rate of interest when the economy is below the natural rate of unemployment are without foundation.

Heterodox authors would add to the RBC empirical observation about the fact that output is not mean reverting, that the supply or capacity limit of the economy is endogenously determined by autonomous spending (the supermultiplier that extends Keynes’ effective demand to explain potential output; for more go here). This does NOT mean that one can expand the economy without limits, since if the expansion of demand is faster than the movement of the capacity limit, eventually full employment would be reached and inflation (demand-pull inflation) might follow. Note, however, than since the 1930s in the US unemployment was below 4% (to say a relatively low number) only for four short periods, during the mid-40s, early 50s, late 60s and late 90s, with inflation occurring in the first three periods. Also, it suggests that the main barrier to the use of demand policies to achieve full employment, at least in developed countries with no balance of payments problems, is political. As Kalecki noted long ago, sound finance would be the political instrument to keep workers’ demands for higher wages in line. The NMC model is the modern incarnation of what Kalecki’s referred to as sound finance. So who is really surprised with the dominance of austerity policies?

Bernard, Gervorkyan, Palley, Semmler: A Review & Critique of Long Wave Theories

In a previous post (see here), I had argued that the capitalist world economy can be conceived as resting on the dependence of historically-specific hegemonic institutions, whose rise and fall follow the trajectory of long waves, what Giovanni Arrighi defined as systemic cycles of accumulation (SCA's), periods of approximately 40-60 years, separated by A phases and B phases (see here). Lucas Bernard, Aleksandr V. Gervorkyan, Thomas I. Palley, and Willi Semmler, however, offer a penetrating critique of this central tenant of the world-systems tradition.

From the abstract:

This paper explores long wave theory, including Kondratieff’s theory of cycles in
production and relative prices; Kuznets’ theory of cycles arising from
infrastructure investments; Schumpeter`s theory of cycles due to waves of
technological innovation; Goodwin`s theory of cyclical growth based on
employment and wage share dynamics; Keynes – Kaldor – Kalecki demand and
investment oriented theories of cycles; and Minsky’s financial instability
hypothesis whereby capitalist economies show a genetic propensity to boom-bust
cycles. This literature has been out of favor for many years but recent
developments suggest a reexamination is warranted and timely. 

Read rest here.

Prabhat Patnaik - Finance and Growth Under Capitalism

By Prabhat Patnaik

Once we reject Say’s Law and recognize that capitalism is prone to deficiency in aggregate demand, we have to accept that sustained growth in this system requires exogenous stimuli. By exogenous stimuli I mean a set of factors which raise aggregate demand but are not themselves dependent upon the fact that growth has been occurring in the system; that is, they operate irrespective of whether or not growth has been occurring in the system. Moreover, they raise aggregate demand by a magnitude that increases with the size of the economy, for instance with the size of the capital stock. They are in other words different from “erratic shocks” on the one hand, and “endogenous stimuli”, such as the multiplier‐accelerator mechanism, on the other: the latter can perpetuate or accelerate growth only if it has been occurring anyway.

Read rest here.

The Failure of American Governance in 1 Depressing Chart

From The Atlantic:

Infrastructure spending has a higher bang for the buck than just about any other kind of spending. The San Francisco Fed, for one, estimates that every $1 of highway spending raises GDP by $2. Second, even if you don't believe in multipliers, infrastructure spending is something we have to do eventually—so we'd save money if we do it when interest rates are low. Third, investors are paying us 0.43 percent after inflation to borrow for 5 years.

Now look at the above, via Cardiff Garcia, of inflation-adjusted infrastructure spending in the U.S. the past decade. Weeping is optional.

 See rest here

Hysteresis and the natural rate

I've been teaching on the price and quantity interactions, and the natural rate or NAIRU (Non Accelerating Inflation Rate of Unemployment), that is the level of activity at which you have price stability. One of the papers assigned is the one by Franklin Serrano (here or here for a Spanish version; another assigned paper is this one by yours truly). By the way, I've dealt with the issue of hysteresis briefly before here, mostly to distinguish it from path dependency, following Setterfield (Serrano also suggests differences between heterodox and more conventional views on hysteresis).

As noted by Serrano, the research by Nelson and Plosser (1982) (here; subscription required) and Real Business Cycle (RBC) authors suggests that GDP follows a random walk, and as a result after a productivity shock (which they measure as changes in TFP, in spite of significant problems with that measure; see here) output does not return to its previous trend. The point is that once the output trend is affected there are persistent effects that change the trend itself, that is hysteresis. Fluctuations are variations of the optimal level itself.

Serrano correctly points out that "this means that the long run trend of output is not only partially determined by whatever drives short run output (presumably aggregate demand) but rather that potential output is actually fully determined by the trend of whatever drives actual output. As it is well known, this result of strong hysteresis in the output (GDP) series has been taken to provide evidence in favor of the 'real business cycles' strand of new classical macroeconomics in which the common element driving trend and cycle are factor supplies and their productivity." The natural rate or NAIRU is supply determined, but is variable (something that, in a different context, Robert Gordon would call the Time Varying NAIRU or TV-NAIRU).

Supply shocks imply that in a boom the potential output moves first, and actual output adjusts as individuals readjust to higher productivity. Hence, the output gap, if defined as the difference between actual and potential output, becomes negative. And if you believe in a Phillips curve and some sort of central bank monetary rule, a negative output gap suggests a deflationary pressure (and yes RBC authors do believe in endogenous money). Yes, that's what the RBC theory implies! In fact, according to Kydland and Prescott (1990): "the price level has displayed a clear countercyclical pattern."*

Serrano points out a simpler (Occam's Razor applies) explanation for the favorable evidence on hysteresis, namely that demand (in fact, the autonomous components of demand) determine potential output (the supermultiplier). Note that this approach does not require, as the RBC or the acceleracionist versions of the Phillips Curve, any definite relationship between prices and quantities. As noted here (and here) before, there is no reason to expect an unambiguous or systematic relation between prices and quantities, unless you think that prices are always driven by excess (or lack of) demand.

As Serrano argues the: "trend and the cycle indeed have a common nature as the empirical literature shows but this common nature reflects that both are explained by demand (not supply) factors" and "with full hysteresis in output levels and partial inertia on inflation, 'demand-pull' inflation is just a temporary phenomenon and therefore does not determine 'core' or persistent inflation." And it is hard not to agree on this with New Keynesians, and their dismissal of supply shocks as the main cause of business cycles. It is harder to agree with their insistence on a natural rate, even if it's variable.

* The obvious historical event they would have in mind is the stagflation of the 1970s. Note, however, that more often than not deflationary periods are contractionary, like the 1930s. Of course the oil shocks and the increase in costs can explain, together with wage resistance and price inertia, the inflationary pressures of the 1970s in a model that is perfectly compatible with demand driven recessions.

Stock-Flow with Consistent Accounting (SFCA) models

Gennaro Zezza, student and co-author of the late Wynne Godley and currently responsible for the Levy Institute macroeconomic model, gave an interesting talk on the usefulness of Stock-Flow with Consistent Accounting (SFCA) approach to macroeconomic modeling. He refers to the models as stock-flow consistent (SFC), but I prefer to emphasize that the consistency is not just about the relation between stocks and flows, but also the fact that these models provide the full set of accounts (website for those interested in this approach here).

SFCA proved to be considerably more successful than conventional, in particular Dynamic Stochastic General Equilibrium (DSGE) models, in predicting the Great Recession (see here paper by Dirk Bezemer).

As noted by Gennaro, the fundamental principle of SFCA models is that:

"in the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: 'there are no black holes.' This obvious principle has relevant implications: one is that the debt of somebody is a credit for somebody else."

Note that this fundamental principle has more to do with the fully consistent accounting part of the model, than with the relation of stocks and flows. But stock-flow relations are also essential, since flow decisions of spending are tied to stocks. Private agents can spend if they have access to stocks of credit, of accumulated assets, that is, some stock of wealth. The State often has the power to spend and accumulate a stock of debt, since it can decide (Functional Finance and Chartalist approaches, which are implicit in Godley's work, become important here) the token in which debts are denominated.

One of the questions raised in the presentation was about the supposed lack of behavioral assumptions and expectations in the SFCA (as compared with DSGE models). First, it should be forcefully noted that there are behavioral assumptions, and those are strictly speaking based on Post-Keynesian (classical-Keynesian, I would say) principles. So agents autonomous decisions to spend create income, and in the models, I would add, investment follows an accelerator, so it tends to be derived demand, with the stock of capital adjusting to the flow of income (a relatively stable stock-flow relation, associated to the normal degree of capacity utilization).*

While DSGE models presume that an exogenous potential product (determined by supply side factors in a Ramsey/Solow/Lucas/Romer tradition) drives the economy, and deviations from it are corrected by price and wage flexibility, these models have an endogenous demand-driven output trend, which is really why they do better explaining the real world, including the Great Recession.

On the question of expectations Gennaro was clear, as a Post-Keynesian (PK) he is not particularly interested in expectations. He, however, suggested the possibility of using what Tom Palley refers to as model consistent expectations. That is, agents use expectations that are consistent with model (in this case the PK model, and, hence Lucas's problem is not that agents use all the available information, but that he has the incorrect model). Mind you the introduction of this expectational framework does little to improve the ability of the modeler to understand reality.

Finally, I want to note that while I do think that it is essential that these models, which are an alternative to applied DSGE models used around the world in Central Banks, international organizations, think tanks, and other institutions that managed to miss every single sign of the crisis, are developed and used more by economists, they should not be seen as the only modeling strategy available to heterodox economists.

In my view, the stock-flow and the demand driven (and I should say, the fact that price dynamics is orthogonal to the income flow determination structure)** is the essential characteristic of this approach. But the empirical, macroeconometric models that Gennaro and Wynne build have, more importantly, the full set of accounts, something that is essential for the empirical models, but sometimes too cumbersome for making a theoretical point. Hence, sometimes models that present the stock-flow dynamics (in a classical Keynesian perspective), without the full accounts (see here, for example), are necessary, useful and more directly relevant for the task of providing theoretical insight into a specific problem.

* This means that these are supermultiplier models in the Kaldorian tradition, which should not be a surprise since Wynne was a disciple of Kaldor. In fact, Kaldor was responsible for bringing Wynne to head the Department of Applied Economics at Cambridge in the late 1960s.

** Wynne was a student in Oxford of Andrews, one of the main authors of the Full Cost Pricing School.

And here's to you, Mrs Robinson

Jesus loves you more than you will know (wo, wo, wo) ...I know, but I was going to talk about the other Mrs Robsinson, Joan Violet (née Maurice), the main disciple of Keynes,* as I had promised in a previous post. Joan Robinson's contributions to economics demand several posts. She has participated, as Maria Cristina Marcuzzo noted, in three Revolutions, namely: the imperfect competition, the Keynesian and the capital debates ones.

And to reduce her to those three one has to fit her contributions to growth theory into a subcategory of either the Keynesian Revolution (the extension of the Principle of Effective Demand to the long run) or the capital debates (the critique of mainstream growth theory), and omit her various other contributions to monetary theory (e.g. endogenous money and the circuit), methodology (e.g. history vs. equilibrium), Marxist economics and so on. She was prolific for sure.

There are several great reviews of her contributions in all of them, which would make my post irrelevant. But what I want to discuss is the point raised in Sergio Cesaratto’s presentation, that in the last one of those revolutions her contributions might have been seen as negative. In his exposition Sergio emphasized quite correctly her rejection, at least in certain contributions, of the notion of long term normal equilibrium positions, and, hence, the traditional method of economics.

This was done, for the most part, to emphasize the notion that history matters and that path dependency was important, since the process of reaching the equilibrium would affect the equilibrium itself. Arguably, the role of uncertainty, following Keynes and some post-Keynesians, played a role in her rejection of normal equilibrium positions.

Path-dependency is indeed an important feature of real economies, and Robinson was quite right in emphasizing its relevance.++ However, the fact that the normal or long run equilibrium positions might depend on the initial conditions and on the trajectory to its final position would render the very notion of equilibrium irrelevant for the analysis of real historical situations might not be granted.

In her view, the notion of equilibrium originated from a misleading mechanical analogy with movements in space, and shouldn’t be applied to movements in time.  However, nothing suggests that the long run position of equilibrium cannot be path dependent and actually represented by an equilibrium position. Let me suggest that the idea of the supermultiplier is, for example, a case in point. Output depends on the autonomous components of demand, and investment, as derived demand, behaves in a way which leads to the adjustment of capacity (supply conditions) to demand.  It is an equilibrating process, but not a unique one, or one that leads to a determinate path of accumulation, since alternative initial conditions (e.g. sizes of the relevant coefficients) lead to different outcomes.  Also, changes in several factors can affect the trajectory by which capacity adjusts to demand.

Further, uncertainty, or true, fundamental and non-probabilistic uncertainty was also a relevant component of Robinson’s critique of equilibrium positions. Uncertainty also suggests that historical processes are complex and could not be reduced to equilibrium analysis. This was also in line with the post-Keynesian developments in the 1970s, by Paul Davidson and others, that suggested that uncertainty was central for Keynes understanding of the functioning of the economy.

That is again true. Uncertainty was important for Keynes, and is central in the functioning of real economies. However, uncertainty does not preclude the use of equilibrium. Uncertainty implies that agents use conventions, rules of thumb in order to make decisions. In an uncertain world agents stick to social norms, and even if there is significant uncertainty on an individual basis, the institutional framework tends to reduce uncertainty. In that sense, for example, the New Deal reforms decreased to a great extent the degree of uncertainty in the functioning of the economy, and guaranteed a high degree of stability to workers.  Another example of how institutional framework would reduce uncertainty is the use of capital controls (and fixed but adjustable exchange rates) to reduce the pressures on interest rates during the Bretton Woods era. With that framework, fiscal expansion with low real rates of interest produced a normal equilibrium with low unemployment level. In other words, nothing implies that uncertainty suggests that the multiplier and accelerator processes are not operational or that normal positions of equilibrium cannot be achieved.

In my view, the two main problems to Joan Robinson’s critique of the equilibrium method in the latter part of her career are that, on the one hand, by emphasizing the independence of the investment function and of uncertainty it led to the development of a set of models (later incorrectly referred to as Kaleckian) that bring back the entrepreneur as the central figure in economic growth (the so-called profit-led regimes). On the other, and even more problematic, it took place at the same time that (as noted by Garegnani) the mainstream rejected the old notion of long term equilibrium, and started to use dominantly the intertemporal models (this ones in fact terrible mechanical analogies to movement in space).

The old classical (and indeed even the old Marshallian) notion of normal positions, which allowed for historical contingency and path dependency was abandoned by the mainstream, but that was seen by several heterodox authors as an improvement because now mainstream models were ‘capable’ of incorporating multiple equilibria and instability. In fact, Keynes point was that normal situations (and hence stable equilibrium positions) in capitalism were sub-optimal. And Joan Robinson, at least in part, is responsible for some of those heterodox (very confused) views of the development of the mainstream.

---

* Richard Kahn would be the other candidate, but his contributions to the Keynesian Revolution were considerably less visible, if admittedly incredibly important, with the formalization of the multiplier on the top of the list. Kalecki and Kaldor, although quintessential Keynesians, were not disciples of Keynes in a direct way, and Sraffa, although personally close, and contrary to what some think, very favorable to the idea of effective demand, was not a disciple proper either.

++ Note that path-dependency is not exactly the same as hysteresis, a point raised by Mark Setterfield. I’ll expand on this on another post.

PS: A paper in which some of the pros and cons of Robinson's approach to economics, in particular on money and growth, is available here (subscription required).

Sraffian economics vs. Post Keynesian methodology

A very nice debate on the nature of heterodox economics took place yesterday in a heterodox conference in Buenos Aires. Sergio Cesaratto and Marc Lavoie (depicted above during the interval) presented alternative views which, in spite of some important differences, agreed that Sraffian economics is part of the broadly defined heterodox Keynesian camp (or Post Keynesian if one prefers the term). The question of the relation of Sraffians, and more broadly all of those that believe in the importance of the old classical political economy school (from Petty to Marx, including Quesnay, Smith and Ricardo), with non neoclassical Keynesians, that is, those that believe that unemployment does not result from some rigidity or imperfection (be that of the price, wage or interest rate), has been difficult to say the least.

Marc presented first. A version of the paper is here. Taking aside obvious confusions, and sloppy scholarship of the type that suggests that Sraffians accept Say’s Law, because in the determination of normal prices quantities are taken as given (the fact that those quantities are determined by demand in accumulation theory is, apparently, not understood by these critics), the main line of critique of Sraffians comes from what Marc refers to as Post Keynesian methodologists. For him, “the influence of methodologists ... felt through the study group around Tony Lawson at Cambridge ... that [argues that] proper economics should be based on critical or transcendental realism and ‘open’ systems” and that has led to an “‘open systems’ criterion to judge whether a model can be given a post-Keynesian stamp of approval” (Lavoie, pp. 6-7).

Marc correctly dismisses this supposition that from a methodological point of view the Sraffian approach is limited to closed models. As he clearly notes the Sraffian price equations require that one distributive variable (real wages or rate of profits) are determined exogenously outside of the system by historical and institutional circumstances, which by definition makes it an open system, that is, one in which there is an exchange with its environment. Marc, in fact, suggests that the strong case for a Sraffian-Keynesian interaction is based on the fact that the determination of the rate of profit by the exogenous short term rate of interest set by the central bank provides an obvious link to Post Keynesian endogenous money literature (Pivetti and Panico’s work in that area, among others, shows that Sraffians do have a lot to say about money too, by the way).

Marc notes that the main reason, however, why Post Keynesians reject the Sraffian approach is there is “little enthusiasm for any notion of long-period ‘prices of production’ as centers of gravity towards which short-period or market prices are supposed to tend” (p. 14). However, as Marc suggests there is little difference between prices of production and full cost pricing. Full cost pricing, in my view, should be connected to the Oxford Economists Research Group (particularly P.W.S. Andrews, a tradition that through Andrews’s disciple Wynne Godley influenced Cambridge Keynesians). In other words, I see full cost pricing as compatible with the normal prices in Sraffa, both being determined by a mark up, which represents the social conflicts that allow one class to subtract surplus from another, over costs, which are determined by the technical conditions of production.

My main disagreement with Marc’s exposition, then, is related to his argument that “if one wishes to connect Sraffian economics with the other strands of post-Keynesian economics, one needs to examine production prices in a different light, not as long-run or long-period centers of gravity to which market prices tend” (p. 15). This is also complicated by the incorrect notion that gravitation requires the use of marginalist principles in order to obtain that market prices converge to normal long term prices, which is not the case [I’ll leave the details of that for another post though]. It seems to me that Marc believes somehow that full cost prices are somehow not fully adjusted prices, and that firms do not use their normal costs rather than their short run costs when computing prices.

Sergio counter presentation (not available, but you can check some of his extensive publications here), was narrower in scope, and dealt with the difference between certain Post Keynesian growth models (in particular the so-called Neo Kaleckian school) and Sraffians (he also distinguished among certain Sraffian groups). I should note that Cesaratto agreed with Marc in his rejection of the critique of the so-called Post Keynesian methodologists, and suggested that their lack of understanding of the capital debates and its consequences, reduces the significance of their views. He correctly points out that the capital debates produced the only occasion that forced neoclassical economics to openly recognize its flaws, and, I would add, led to a significant change in the way they do economics, forcing the change in the notion of equilibrium and the development of disaggregated intertemporal short term models (i.e. without a uniform rate of profit, something first noted by Piero Garegnani).

Sergio notes that when dealing with models of accumulation there are three features that most heterodox groups would want to incorporate in their models, namely: (A) the Classical (or in general exogenously given) income distribution, (B) the Keynesian Hypothesis of an investment rate independent from an exogenously given rate of savings, and (C) normal accumulation paths, with the traditional corollary of a long run normal degree of capacity utilisation. Between these three features one obtains what Sergio refers to as the Magical Accumulation triangle.

Neo Kaleckian (NK) models (some of Marc’s models, particularly in his Foundations of Post Keynesian Economic Analysis are of this type, but not the ones in his book with Wynne Godley) tend to assume A and B, but not C. The absence of the notion of normal (or fully adjusted) positions, as we saw above with regards to prices, is the main difference between the NKs and what Sergio calls the supermultiplier Sraffians (which have A, B and C). The supermultiplier models (which are in a sense Kaldorian, on Kaldor and Sraffa see this paper) implies that long term capacity output (not optimal in the sense of full employment) is determined by the exogenous components of demand, and investment is derived demand (as noted by Sergio the key contribution here is Franklin Serrano’s PhD thesis).

Here it is important to note why long term normal positions are important. It has little to do with a belief that economic systems are stable and tend to optimal levels, since the normal positions are tendencies, and are, generally, below full capacity, and crisis are the norm. Normal positions are important because they show that the regular functioning of capitalist economies does not produce efficient allocation of resources. Without suggesting that those that deny the relevance of long term positions are imperfectionists in the same sense that neoclassical authors that believe that an accumulation path below full employment is due to price, wage or interest rate rigidities, the argument still relies on an inability of capacity to adjust fully to the exogenous growth of the autonomous components of demand. The question then is why would a business not invest enough to keep its capacity growing in line with the growth of its demand? Here, I believe, lies the fundamental difference between classical-Keynesians (or supermultiplier Sraffians) and Neo Kaleckians.

By the way, as I noted before in the blog, the use of the term Kaleckians for the NKs is a bit of a misnomer, since the models derive really from Joan Robinson (and as noted by Sergio, Harrod and Steindl too). In part, I think, for her role in the rejection of normal positions and her views on history versus equilibrium, Sergio suggested that Robinson played a negative role in these debates.

There are several other things to discuss about this topic (the role of Joan Robinson among the important ones), brought about by the interesting, controversial, but very friendly debate between Marc Lavoie and Sergio Cesaratto which I’ll leave for other posts.

More on income distribution and growth (wonskish)

Kaldor and Kalecki

A few years back Sam Bowles presented a paper (Kudunomics: Property rights for the information-based economy) at the University of Utah. At dinner he reaffirmed his conviction that Arrow-Debreu General Equilibrium (GE) is compatible with different kinds of behavior and can be a force for progressive economics. Conventional marginalist theory suggests that income distribution is the result of relative scarcities, and, as a result, real wages should equal the marginal product of labor, i.e. labor productivity. When asked how he squares the belief in GE with the fact that wages in the US do NOT follow productivity since the 1970s, Bowles seemed puzzled. And the relation of income distribution and growth remains puzzling for the mainstream and its sycophants.

In the heterodox camp, the discussion has been centered, for the most part, between the so-called Kaleckian and Kaldorian models. First, I should note that from a history of ideas point, the Kaleckian name is a misnomer. Kalecki’s models where about the interaction of multiplier and accelerator, with shocks and lags, to produce fluctuations. In the various forms of his accelerator equation Kalecki included a trend, producing fluctuations around a trend. The so-called Kaleckian models derive from Harrod and Joan Robinson’s attempts to extent Keynes’ Principle of Effective Demand (PED) to the long run.

The PED says that an increase in investment is matched by an exact increase in savings, and that the level of income is the main adjusting variable (rather than the interest rate as in the Loanable Theory of Funds). The Kaleckian models basically normalize the IS identity by the capital stock, assume (in the extreme case) that the propensity to save out of wages is zero, and a propensity to save out of profits (s) between zero and one, and in Keynesian fashion have investment determine savings. The difference with the short-run story is that now accumulation (investment-to-capital ratio) determines income distribution (the rate of profits), a result often referred to as the Cambridge equation.

The various incarnations of the Kaleckian models are defined by the way the investment function is specified. For example, in the influential paper by Bhaduri and Marglin (B-M) (subscription required) they argue that investment and savings are functions of the profit share (h) and capacity utilization (z). In other words:

I(h, z) = shz

Solving for z and deriving with respect to h we have:

dz/dh = (Ih – sz)/(sh – Iz)

Where Ih is the response of investment to profitability and Iz to capacity utilization. Assuming stability, that is, that savings respond to profitability more than investment to capacity utilization and the denominator is positive, the sign of the equation depends on the numerator. If investment is strongly responsive to profitability (Ih > sz), then the system is profit-led (exhilarationist in B-M terms). If not we have the wage-led (stagnationist) regime.

As I suggested in my previous post, there are some theoretical problems with the type of model used to argue that the US economy is profit-led, besides the empirical ones alluded before. The independent investment function suggests that capacity utilization affects capital formation, if capacity is low there is more investment, and vice versa when z is high. In other words, firms would try to adjust capacity to demand. If that is the case you would expect that a normal relation between capacity and demand would be established in the long run (in the neoclassical view demand adjusts to capacity; that’s Say’s Law), which could be seen as the relatively stable output-to-capital ratio over the whole period for the US, in my previous post.

If that is the case, investment is determined by the adjustment of capacity to exogenous demand in order to reach the normal capacity utilization, and it is essentially derived demand (the accelerator principle). It is not instrumental in determining the normal level of capacity utilization, which must be determined by the exogenous components of demand. This is the basis of the supermultiplier models, first developed by Hicks, and then by Nicholas Kaldor, and referred to as Kaldorian in the heterodox literature (for more on that see this paper).

That is the essential difference between the Kaleckian and Kaldorian models, whether investment is partially autonomous and determined by profitability or it is derived demand. Of course income distribution in Kaldorian models might have ambiguous effects on growth, but firms would not investment more if profits went up, if there is no increase in demand. In this sense, worsening income distribution might lead to higher growth if demand keeps going for some reason (say more private debt stimulates consumption; or stimulates the consumption of a higher income group). But in general profit-led growth that stimulates investment, as in the M-B framework seems hard to explain from a theoretical point of view. Hence, the confusion it generates empirically (e.g. in the case of the US the notion that a debt-led consumption boom is a profit-led story).

PS: The typical Kaldorian model is based on Thirlwall's work, but the book by Bortis and Serrano's dissertation (or his paper; subscription required) are essential readings.