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The Ricardian Law of Diminishing Returns. a Ew Interpretation

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The Ricardian Law of Diminishing Returns. a Ew Interpretation The Ricardian Law of Diminishing Returns. A ew Interpretation . Leveraging productivity to drive globalization. Lucy Badalian — Victor Krivorotov 11501 Maple Ridge Rd Reston VA 20190 Millennium Workshop, USA [email protected] Abstract . The 2009 IMF report found notable differences between the pre- and post-1985 busts in their ratios of capital/labor. According to historical trends it cited, the recent extreme financialization may cloud our mid-term recovery prospects. The Market Pendulum Model (further MPM) stresses the importance and fluidity of interrelationship between traditional factors of production: land, labor, capital and entrepreneurship. MPM shows the difference between productivity-factors during demand shocks, such as today, and supply shocks (the 1970s-80s). It traces the causal roots of the financialization in market’s compensation for failing fundamentals, the direct result of the Ricardian Law of Diminishing Returns (further RLDR). Keywords : Ricardian Law of Diminishing Returns, financialization, financial crisis, demand shocks/demand shortages, supply shocks/supply shortages, ratio of capital/labor. JEL codes: E1, E20. E5, E6. 1. Introduction. The Interrelationship between Various Factors of Production as a Potential Predictive Tool. The October 2009 report of the IMF showcased the importance of the hitherto under- researched area of the inter-relationship between factors of production, which, in its opinion, holds significant predictive power as to the length and severity of the unfolding recession. It found that the growth in productivity since 1985 was accompanied by a rapid rise in the ratios of capital to labor. Earlier research noted other specific patterns of labor productivity. Among them, the wavelike behavior of multifactor productivity growth, which peaked in 1928-50 and slowed gradually, both when moving back to 1870-91 and forth to 1972-96 (Gordon 2004). The countercyclical rise of productivity was noted during the 1929 Great Depression (Bernanke, Parkinson 1992, Bordo, Evans 1995). It may be conjectured that the latter contributed to the final exit out of the lengthy depression and led to the follow-up strong growth in the 1950s-70s. Meanwhile, despite a long history of studying productivity and its input into economic growth both for the US (Fabricant 1942) and in the economic practice of other countries (Kendrick 1961 and 1982, Kennedy 1971, Salter 1960, Wragg and Robertson 1978), the fluidity of the interrelationship between different factors of production didn’t get its due attention. Its causal roots remain unclear and under-researched, despite the intriguing findings cited above (IMF 2009 report, Bernanke, Parkinson 1992, Bordo, Evans 1995). The ongoing crisis further underscores the importance of the underlying causality, if, as the cited research hints, the changing ratios between diverse factors of production may indeed influence such parameters as the length of the related depression and its severity, importance of which was stressed again recently by Pisani-Ferry and van Pottelsberghe (2009). In this paper, we research the effects of productivity shifts on the economy of the leading country of its time, such as the US today or Britain of the 19 th century. Our main analytical tool is the Market Pendulum Model, further MPM, first presented in (Badalian, Krivorotov 2009). It is used here to shed new light at the rhythmic causality of fluid interrelationships between diverse factors of production. While the topic is extremely complex and our hypotheses need substantial future research, their initial conjectures, provided below, can hardly be ignored and invite further discussion and more testing and input, especially from other researchers. In a nutshell, as it would be shown below, MPM turns from shortages of demand to shortage of supply and back (Badalian Krivorotov 2009) as market shifts from one leading factor of production to another. This suggests that the traditional factors of production, such as land, labor, capital and entrepreneurship may star in leading roles not all at once, but sequentially, in turns. A new factor of production comes to the top as soon as the other supporting factors get exhausted due to the Ricardian Law of Diminishing Returns, further RLDR. Meanwhile, the latter’s influence grows as the economy matures. This would explain the recent growing ratios of capital/labor as an attempt to compensate through extra capital infusions for the negative influence of RLDR exerted on the labor productivity in a mature economy. This explanation finds additional, though indirect, support in the well known fact that mature industries gradually turn more capital-intensive and heavily depend on economies of scale while their margins fall. (Grant 2005: 367) It should be noted that, while RLDR is commonly accepted in the economic practice, its validity as a physical law, able to apply force, still remains unclear. As it was often noticed, starting from Ricardo himself, its influence in practice is often compensated by other factors, such as economies of scale at the root of the comparative advantage. The latter suggests the existence of extensive trade routes, whose support and maintenance, by definition, is extremely capital-extensive, thus bridging together three factors of production: faraway land, global labor and capital. Below, MPM provides a first glimpse at the causal chains, where the exhaustion of a given factor-productivity is compensated through the additional input from another. A shift from one leading factor to its successor is usually accompanied by an MPM-turn from shortages of supply to shortages of demand and back. For example, from the 1929 Great Depression, the US economy resolved shortages of demand through the rise in productivity of its labor (Bernanke, Parkinson 1992). The shortages of supply, which became evident in the 1970s-80s, were resolved in an altogether different way, through capital inputs (2009 IMF report). In its turn, as soon as the follow-up deleveraging causes growing shortages of demand, the solution may come through the rising importance of entrepreneurship, which produces a rising tide of technological innovations – innovation-heavy resolution of a similar situation at the start of the 20 th century was noted by many including (Gordon 2004). As it was expressed through Fabricant’s Law (Fabricant 1942), the decade before WWI notably differed from the depressive conditions at the end of the 19 th century. Not only there was a tendency for a speeding productivity growth to accompany faster output growth, but, due to technological progress, both were correlated with savings in wage costs and materials costs per unit of output and with slower rates of growth in prices. Thus, a rapid technological change and introduction of new business and production models, based on mass production, such as Swift’s meat packing and conveyor, still in its infancy, contributed, even at this early stage, to the substantial rise in production volume accompanied by lower costs. This increased demand on labor, while greatly boosting the value of land, needed to feed and house labor. Below, we summarize the periodical MPM-related shifts during the 20 th century in the US, the leading country of the era. The model, with intentional oversimplification, stresses the causal relationship between factors of production, where the next leading factor comes to the top as soon as its counterpart is exhausted. This is interpreted as the lifecycle of a specific economy of the era. The 20 th Century: the lifecycle of the economy of mass production, US-style. • Entrepreneurship and industrial revolution . From the depression at the end of the 19 th century and up to the 1913 inflationary peak and WWI – shortage of demand was gradually turning into shortage of supplies. The leading factor of production seems entrepreneurship , which boosts the value of land and labor through a major technological shift, with a surge in revolutionary innovations, birth of new industries and the introduction of new models of mass production (Gordon 2004). As Solomon Fabricant (1942) noted, the cost of production drops drastically, while its volume goes up. The higher productivity margins easily support increases in employment. • Land and agrarian revolution in the situation of immature domestic markets . From 1914 and throughout the Great Depression up to the 1940s– the wartime global shortage of supplies gradually morphs into dire shortages of demand in 1919. Land becomes the leading factor of production, when its value starts growing accompanied by surging land prices during WWI. The US industries are still export-driven, thus resource-dependent, and domestic demand remains rather limited. WWI led to huge increases in acreage, leading to extreme agrarian oversupply and drop in prices in 1919 (Olson 2001 : 2). In the course of WWI, the US grew into the main agricultural supplier to the world. The rural debt expanded dramatically as land prices shot up. In 1917 there were more than 24 million draft animals and, from 1917 to 1925, 500,000 Fordson tractors were sold. The productivity of land grows notably, helped by better transport and the early effects of the mass car. Due to huge investments into the rural infrastructure (especially, rural electricity and rural roads) starting from the administrations of Hoover and further intensified during Roosevelt’s New Deal, the US is able to singlehandedly shoulder the great burden of supplying the WWII allies. • Labor and consumption: the rise
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