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What Drives the Capitalist Economy?

Started by Richard Mellor, December 11, 2018, 11:00:36 am

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Richard Mellor

What Drives the Capitalist Economy?

Back to Front 

by Michael Roberts

Is it supply that drives an economy or demand?  Such was the  question asked by Keynesian economics blogger and Bloomberg columnist  Noah Smith.  Smith often raises issues that enlighten us on the  differences (and similarities) between mainstream neoclassical and  Keynesian economics, and, in so doing, where Keynesian theory and policy  differs from a Marxian analysis.

In a recent article,  Smith questioned the traditional neoclassical view of economic growth,  namely that real GDP expansion depends on employment plus productivity  (output per employee).  This neoclassical view, says Smith, means that,  while Keynesian monetary and fiscal policies might get an economy out of  a slump, they can do little to raise long-term productivity growth.   But he begs to differ.

This ?supply-side view? is inadequate, says Smith.  Boosting demand  with Keynesian-style measures of cheap money and government spending  could create the conditions for raising output permanently onto a new  and higher trajectory: ?it may be time to momentarily step away from economic orthodoxy and look at demand-based policies to help boost productivity.? There is a ?demand-side? view of long-term economic growth.

Smith cites Verdoorn?s law as relevant to this thesis: ?Dutch  economist Petrus Johannes Verdoorn describes a correlation between  output and productivity ? when growth is faster, productivity also grows  faster. You can see this correlation in the data.?  This, claims Smith,  ?leaves open the tantalizing possibility that the reverse is happening ?  that high levels of aggregate demand also drive up productivity.?   So, when there is a boom in demand, this leads to more sales and output  and encourages companies to invest more and, as a result, this leads to  rising productivity.  Thus demand creates its own supply ? the reverse  of Say?s law, as promoted by Ricardian and neoclassical economics, that  supply creates its own demand.

So has neoclassical economics got things back to front and all we need to do in economic policy is to keep ?running the economy hot, through continued monetary and fiscal stimulus?? Well, the first thing to say is that Smith?s reference to Verdoorn?s law to support his argument that Keynesian-style demand boosts will sustain  increased productivity is misleading.  Actually, all that Verdoorn  shows is that ?in the long run a change in the volume of production,  say about 10 per cent, tends to be associated with an average increase  in labor productivity of 4.5 per cent.?  This correlation proves  nothing about causation.  So output and productivity growth are  correlated ? surprise! ? but is it total ?demand? or output growth that  stimulates productivity growth, or vice versa?

Smith cites research that is supposed to show the causal connection  from demand to supply, but when you check that research you find that  the authors cited, Iván Kataryniuk and Jaime Martínez-Martín, conclude: ?some  of the deterioration of the TFP (productivity ? MR) growth outlook in  recent years may be explained by a negative business cycle, but  structural weaknesses remain behind the slowdown in medium-term growth,  especially for emerging countries.?  So it?s not demand that is the main cause of long-term productivity growth.

From a Marxist view, what?s missing from this debate, as always  between mainstream neoclassical and Keynesian disputes, is profit and  profitability.  Sure, it is obvious that when an economy is booming and  demand for goods is strong, then companies will usually increase  investment in new technology as well as employing more workers (but I  say ?usually?, because in this Long Depression, it seems companies have  increasingly kept cash or invested in financial assets ie their own  shares, rather than in productive assets).

An expanding economy leads to a virtuous circle of growth, investment  and even productivity growth.  But that virtuous circle eventually  turns into a vicious circle of slump, a collapse in investment and  output that cannot be corrected by easy money or fiscal stimulus.  Why  does a boom turn into slump?  The Marxist view is not because of some  unexplained shock to the harmonious development of the market economy  (the neoclassical view) or some unexplained change in the ?animal  spirits? of entrepreneurs to invest (the Keynesian view).  It is  because, in a profit-making economy (i.e. capitalism), profitability and  profits fall back.  When that happens, as it will at recurring  intervals, then output, investment and productivity will follow.  There  is a profit cycle.

The Marxian view argues that it is the Keynesian view that is back to  front.  Supply leads demand, not vice versa.  But this is not the same  as the neoclassical view that supply creates its own demand (Say?s  law).  For Marx, Say?s law was a fallacy.   In a monetary economy, there is always the possibility of a breakdown  (both in time and inclination) between sale for money and purchase with  money.  Hoarding of money can cause a collapse of sales and purchases.  But what causes that possibility to become a probability or reality?   For Marx, it is a fall in the profitability of capital.

In the Keynesian world of macro-identities, National Income equals  National Expenditure.  National income is composed of wages and profits  and National Expenditure is composed of Consumption and Investment.

NI = NE can be decomposed to
Wages +Profits = Consumption + Investment

If we assume that workers do not save but spend all their wages, then the equation becomes:
Profits = Investment

This is an identity that does not reveal the causal direction.  The  Keynesian view is that Investment (demand) creates Profits (supply).   But the evidence is against Noah Smith and the Keynesians.  The body of empirical evidence is that changes in profitability and profits lead to changes in  investment.  And it is this that decides when there are cyclical booms  and slumps and also the long-term growth path of a capitalist economy

Smith says ?much more research is needed? to see  whether demand creates supply or vice versa.  But the research is  already there.  It is well established that ?easy money? (low interest rates and ?quantitative easing?) won?t work in restoring long-term productivity growth ? as Keynes also  concluded in the 1930s and the evidence of the last ten years confirms.   The search for some ?natural rate of interest? that establishes full  employment and maximum potential output growth is a mirage (reaching for the stars).

And studies (including my own) of the (Keynesian) ?multiplier? effect  of boosting government spending or running the economy ?hot? (Smith) is  much weaker (and even inverse in direction) than the impact of the  profitability of capital on growth and productivity.

Clearly in this Long Depression, hysteresis is in operation, namely that low growth in output and profits has pushed investment and  productivity growth onto a permanently lower trajectory.  But this is  not the result of a lack of ?effective demand? per se, but comes from the failure of the profitability of capital to return to pre-2008 levels and/or to grow fast enough.

Smith may suggest that neoclassical theory has got it ?back to front?.  But so has Keynesian theory.

Source: What Drives the Capitalist Economy?