Why to Worry About the Wealth of Nations: Technological Unemployment, Unequal Distribution and Secular Stagnation

Why to Worry about the Wealth of Nations: Technological Unemployment, Unequal Distribution and Secular Stagnation Timon Scheuer October 14, 2016 Abstract Persistent unemployment challenges politics of today. The cure commonly prescribed is economic growth. While technological progress should still provide the necessary productivity gains, their interdepen- dency to the role allocation of private capitalism may also be an ori- gin or at least a magnifier of stagnation in the first place. In order to investigate these interdependencies the paper takes a system perspective. Within a correspondingly aggregate model technical change affects needs of consumers, expectations of producers and productivity in different ways. Applying a corresponding set of equations in discrete time steps then allows for simulations of exemplary scenarios. In ab- sence of public interventions and institutions the stability of the system and its growth path strongly depends on the mixture of process and product innovation. If the latter fails to overcome temporary limita- tions of needs and expectations, the lack of demand may induce a loop of unemployment and stagnation. This risk increases with disparity, which itself may be triggered by certain forms of technical change in the first place. PROCEEDING OF A PRELIMINARY PRESENTED AT THE YOUNG ECONOMIST CONFERENCE 1 1 Introduction Social scientists know the name of Adam Smith (1776, [2006]) and his fa- mous Ìnquiry into the Nature and Causes of the Wealth of Nations`. He may even be seen as the father of economic liberalism emphasizing the role of spreading market interactions, the division of labour and the accumula- tion of capital in order to achieve productivity gains and boost economic growth (Sturn, 2008, pp. 71-74). The underlying understanding of the link between economic growth and productivity gains may be illustrated best by a tautology transformed into an equation of growth rates (see eq. 1). The growth of income per capita then depends on the development of three ratios. Y Y E L Y^ Y^ E^ L^ = ! = + + (1) N E L N N E L N First, there is productivity in terms of real income (Y ) produced per hour of employment (E). Secondly, there is the ratio between employment and labour force (L). Thirdly, there is the ratio between labour force (L) and population (N) { both also considered in terms of hours. Recent discussions about demographic change in developed countries then clearly hint on a declining ratio between labour force and population. Similar, issues of underemployment hint on a rather declining ratio of employment and labour force. The potential for economic growth in terms of income per capita therefore is provided by productivity gains. An increase in income per capita, though, does not necessarily imply an increase in individual income for the whole population. For the major part of the population individual income depends on wage rates paid to employees. Unemployment therefore implies a shortfall of income. This implication reaches beyond the directly affected individual as income is an important determinant for aggregate demand. Corresponding interdependencies have to be discussed in order to answer the main question: how may ongoing technological progress and productivity gains leave scope for unemployment and stagnation? This paper therefore takes a system perspective on market economies that follow the rules of private capitalism. A remarkable difference to com- parable approaches probably is the separation of product and process innovation. To treat product and process innovation as independent occurrences may be seen critical. A new good probably is produced by a new process and may provoke the adaptation of existing processes as well. The simplification made here, though, does not contradict this fact. It only presumes that effects of inventions may be divided up among both considered types of innovations. The term product innovation in the following refers to inventions that positively and directly affects the portfolio of goods of final demand. It does not refer to intermediate goods and their implications for 2 production. In other words, progressive effects captured by product innovations are those which do not affect the average productivity of existing production structures. Progressive effects that do affect productivity but not needs are separately addressed by the term of process innovation. While this seems like a rather strong assumption, it does not seem that critical within the chosen framework of the model illustrated and discussed in the second section. The third section applies the model in order to dis- cusses direct and indirect threats inherent to the institutionalized system and its potential limits. The fourth section then introduces a disaggregate discussion and argues about the potentials and limits. The latter do not only refer to resources, but also to restrictions in time and heterogeneous consumer preferences. Based on these considerations finally some conclusions are drawn for scientific as well as for political analyses. The derived argu- ment clearly supports redistributive measures and public policies in order to stabilize effective demand. 2 System view and aggregate model The major consideration of market economies refers to a decentralized decision making instead of centralized ruling. The discussion of discrete decisions and their interdependencies within an economic system does not necessarily benefit from the common analytic elegance of the mainstream economic theory. Instead a plausible understanding of functional chains is better derived in a systemic but mathematically simple way. The difference between decisions and interdependencies then may become blurred in analytical terms as both are incorporated as sort of systemic routines. The aim, though, is to take a more comprehensive perspective while simultaneously avoiding com- plexity (see fig. 1). In the following rather simple equations try to represent basic routines that are assumed to determine interactions in an economy with a constant population. According to the definition of economic science economic activities are those that serve the satisfaction of human needs (Wöheand Döring,2008, p. 1). Needs therefore build the microfoundation for decisions to be made and the most fundamental decision to make has to be: what is needed? 2.1 Consumers' demand The theory of decentralized decision making in market economies refers to the question of needs, desires and demand with an own traditional term: consumer's sovereignty. It captures the believe that it is the individual consumer who finally controls the production system (Jeschke, 1975, pp. 19-20). He or she decides what can be sold at which price and thereby what is worth to produce. The marginal willingness to pay of individuals sums up to aggregate demand. It is aggregate demand then that defines for every price 3 Figure 1: Schematic sketch of economic interdependencies in market economies the corresponding quantity of goods saleable to consumers based on their income and preferences (cf. Pindyck and Rubinfeld, 2009, pp. 161-165, 177- 178). Preferences thereby are what represents the link to needs in basic microeconomics. The flow of disposable income determines the monetary means available to households. The temporary available household funds, considering inflows but no outflows yet, then somehow represent what in basic microeconomics defines the budget constraint (cf. Pindyck and Ru- binfeld, 2009, p. 123). Together with prices (ρt) the budget constraint (βt) determines the quantity of goods affordable to the consumer. That some- thing is affordable, though, does not necessarily imply that it is also needed. Within the consumers' budget constraint consumer's needs (ηt) therefore finally determine the quantity of goods actually demanded. The demand x for goods (δt ) based on needs and affordability therefore is the consumer's crucial decision. Assuming needs to be given in real terms of goods the decision may be described as the minimum of just two terms (see eq. 2). x βt δt = min ; ηt (2) ρt 4 2.2 Goods market Aggregate demand then is the outcome of the decisions of several consumers and thereby determines what can be sold if it is supplied at corresponding prices. Prices then at best are efficient and market clearing. Such prices are the outcome assumed for perfectly competitive markets in basic microeconomics (cf. Pindyck and Rubinfeld, 2009, pp. 54-58). There remains reasonable trust in the market mechanism and prices as its tools. That means that prices provide a balancing function. They may not truly reflect marginal willingness to pay but act as signals for scarcity. To this effect, at the chosen level of simplification it may be allowed to treat prices as market outcomes somehow indirectly decided by both sides: increasing with an overall increasing demand, decreasing with an overall increasing supply x (σt ). Similar to the Cobweb-theorem then prices adapt in order to reduce any excess supply or demand and move the market towards an equilibrium (Klump, 2011, p. 62). Sticking to simplification the assumption of propor- tional adaptation seems suitable (see eq. 3). Rigidity (Ξ) then decides about the final adaptation. x δt ρt+1 = Ξρt + (1 − Ξ)ρt x (3) σt 2.3 Producers' supply With regard to the supply side of the consumption good market this of course seems critical because price setting usually is based on marginal or at least unit costs. Also in basic microeconomics the cost structure of firms determines the quantity of goods produced. Producers there decide about a profit maximizing quantity considering costs as well as the consumers' demand and thereby implied marginal revenue (cf. Pindyck and Rubinfeld, 2009, pp. 366-368). Prices therefore are once again treated as just implicitly decided by the consideration of consumers' demand. When demand is given in terms of a function that defines a saleable quantity for a given price it simultaneously defines an achievable price for a given quantity. The supply of goods remains the crucial decision variable for the producers.

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