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

Timon Scheuer

October 14, 2016

Abstract Persistent unemployment challenges politics of today. The cure commonly prescribed is . 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 per- spective. 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 (1776, [2006]) and his fa- mous ‘Inquiry 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  Yˆ  Yˆ  Eˆ   Lˆ  = → = + + (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 em- ployment 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 . 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 inno- vation. 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 simpli- fication 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 in- ventions that positively and directly affects the portfolio of of final demand. It does not refer to intermediate goods and their implications for

2 production. In other words, progressive effects captured by product inno- vations 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 con- sumer 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 deci- sion making instead of centralized ruling. The discussion of discrete decisions and their interdependencies within an does not necessarily benefit from the common analytic elegance of the mainstream economic the- ory. Instead a plausible understanding of functional chains is better derived in a systemic but mathematically simple way. The difference between deci- sions 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 (W¨oheand D¨oring,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 con- sumer 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 ag- gregate 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 . The flow of disposable income determines the monetary means available to . The temporary available 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 microe- conomics (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 . 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. They only can decide about the quantity of goods produced in the actual (ot) and previous periods but not sold for consumption (θt) yet. In other words it is inventories after production but before sale (χt) that determines the upper limit for goods supply. Whether all providable goods are supplied probably depends on the durability of goods as well as on expectations (ξt) about the status quo of the market and the economy as a whole. Real consumption may provide a suitable reference for the economic state. In favour of simplicity goods supply is also determined as the minimum of just two terms (see eq. 4). Whether all providable goods are actually provided there depends on whether consumption is expected to increase and to which extent.

5 x σt = min{χt, (1 + ξt)θt−1} | χt = χt−1 + ot − θt−1 (4)

2.4 Consumption and sales Like demand also supply determines not only the finally achieved price but also an upper limit for actual consumption. Consumption is nothing but the quantity finally sold to households. Together with prices it determines sales (ζt). Sales represents the direct monetary flow from consumers to producers (see eq. 5) or in more general terms from households to corporations.

x x ζt = ρtθt | θt = min{δt , σt } (5)

2.5 Producers’ demand The monetary flow generated by sales refreshes corporate funds for upcom- ing production. Upcoming production is not implied by the existence of funds alone. As previously stated, the decision about quantity depends on costs. Costs are caused by the employment of production factors (cf. Pindyck and Rubinfeld, 2009, pp. 308-309). The model considers labour as the only and thereby representative production factor. Labour in prin- cipal is traded at a market just like goods. In the case of labour, though, producers’ decide about demand instead of supply (cf. Pindyck and Rubin- feld, p. 684). Temporary corporate funds available to pay costs (κt) and the price of labour, the wage rate (ωt), determines the quantity of labour that is affordable. Expectations (ξt) then determine whether this budget l constraint is fully utilized in terms of labour demand (δt) considering past consumption and actual productivity (ψt). Within a simplified view again the minimum of just two terms is selected (see eq. 6). Whether available funds are entirely invested in labour depends on whether consumption and thereby effective demand is expected to increase and to which extent.   l κt θt−1 δt = min , (1 + ξt) (6) ωt ψt

2.6 Labour market As for the market of consumption goods also for the labour market the mech- anism of prices as signals is assumed to work. The wage rate acts balancing with regard to scarcity: it tends to increase in case of excess demand and it tends to decrease in case of excess supply (cf. Pindyck and Rubinfeld, p. 695). To this effect both sides are assumed to indirectly decide about the wage rate instead of directly negotiating it. Again this does not reflect the reality of market interactions, but captures the principal tendency and

6 a so far plausible belief. Like the scope for individual price setting the bar- gaining position at the labour market somehow depends on the proportion between demand and supply (cf. Pindyck and Rubinfeld, 2009, pp. 700-702). Therefore it once more seems a suitable simplification to restrict the direct decisions to quantities and assume a proportional adaptation of the wage l rate according to the ratio of supply (σt) and demand (see eq. 7). The final adaptation is again also determined by rigidity.

l δt ωt+1 = Ξωt + (1 − Ξ)ωt l (7) σt

2.7 Consumers’ supply The quantity of labour supplied is the second crucial decision to be made on the consumers’ side. Like goods are provided by producers, labour is a provided by consumers. This hints on the fact that this terms are sensitive to confusion. The consumers of goods are producing labour that is consumed by the producers of goods. To ensure clarity about the role allocation within the economic system the system perspective illustrated above also used the terms of households and corporations. With regard to labour households now act as supplier. According to basic microeco- nomics the decision about labour supply and thereby the decision about the use of individually available time is once again based on preferences. While working time generates income, leisure is the generic term captur- ing several generated aside market based consumption (cf. Pindyck and Rubinfeld, 2009, pp. 691-693). The of income is predominantly determined by material wealth affordable by this income. More generally speaking therefore the decision about labour supply and correspondingly the use of naturally given time as a resource crucially depends on needs. The maximum of time consumers are willing to give up for work (φ) provides a limit to this decision. As the market mechanism works via prices it seems suitable to focus on the material argument and monetary incentives in order to determine the final amount of time provided to the market. Taking needs for consumption goods as given, prices of finally demanded goods determine the desired level of income. Considering income generated by dividends (ιt) there remains a rest which has to be earned by wages. Taking the wage rate as given, labour supply is the quantity of time necessary to generate the residual not provided by dividends. This quantity of time then decreases as the wage rate increases (see eq. 8).   l ηtρt − ιt σt = min , φ (8) ωt

7 2.8 Production and income

Employment (t) then is just the minimum of labour supply and labour demand. Together with productivity (ψt) it determines the production of goods in real terms. At the same time it is the production process that has to provide income – added up by labour costs (γt) and dividends. Income is the only incorporated inflow of household funds (see eq. 9).

l l µt = ιt + γt | ot = tψt, t = min{δt, σt} (9)

2.9 and The possible use of income and thereby generated household funds has to account also for savings. According to basic and focussing on flows only, savings are the residual from disposable income and expen- ditures captured by sales. According to this logic they are household funds that are not spent for consumption (cf. Blanchard and Illing, 2009, p. 575). A more comprehensive and systemic perspective, though, has to discuss the implication on stocks as well as on flows. Savings may still be discussed as a residual. Households’ decision about consumption imply what is temporary left from household funds. Except a rather small part depending on (λ) the rest is accounted for savings (see eq. 10). At this point it is important to remark the very narrow interpretation of liquidity preference within the sketched perspective – it is a preference to hoard cash.

βt = βt−1 + µt − ζt−1 − αt−1 | αt = (βt−1 − ζt)(1 − λ) (10) Savings therefore represent the part of household funds that continually + build up fairly long-term deposits (dt ). The stock of deposits then is noth- ing but the cumulated flows of savings. Deposits in turn are one foundation − for loans (υt) and thereby implied debt (dt ). Basic macroeconomics often draw a rather direct line from savings to investment (cf. Blanchard and Illing, 2009, pp. 127, 575). Such a direct line is not assumed here. Corpo- rate funds only determine the budget constraint while, as described before, actual labour demand as real term investment also depends on expectations. Corporate funds then grow with sales and intentionally acquired flows from deposits (see eq. 11).

κt = κt−1 + ζt−1 − γt−1 − ιt + υt (11)

2.10 Liquidity and reserves Loans therefore are determined as the minimum of the demand and supply of liquidity. On the one hand an expected growth in sales may allow for a corresponding growth in costs which demands liquidity. On the other

8 hand deposits not acquired yet in terms of debt and the reserve ratio (ν) determine the endogenous supply of . This endogenous supply may + be complemented by an increase in the money base (mt ) as another source of liquidity (see eq. 12).

+ + − υt = min{(1 + ξt)γt−1 − κt − ιt, (1 − ν)dt + mt − dt } (12) At this point the importance of liquidity preference and reserve ratio may become clearer. Assuming that any bank deposit has to be held reserved by hundred percent any such would mean divesting money from the circular flow. The same can be said about household funds held back in terms of cash.

2.11 Costs and dividends Households can only hold back what they already have. The previously dis- cussed sources of income – dividends and wages – are finally found on two market outcomes. Dividends are determined according to adaptive expec- θ tations in terms of the consumption growth rate (gt ). They are paid for profits and profits are what remains from sales after labour costs are paid (cf. Pindyck and Rubinfeld, 2009, p. 366). Labour costs in turn are de- termined by the wage rate and employment provided in the labour market. (see eq. 13).

θ ιt = πt−1(1 + gt−1) | πt = ζt − γt, γt = tωt (13)

2.12 Technology, needs and expectations The so far discussed decisions made by households and corporations crucially depend on needs and expectations. So the remaining question is, how those needs and expectations are formed and developed over time. With regard to needs basic microeconomics provides some ideas. On the one hand there is an assumption about preferences that states that more is always better than less (cf. Pindyck and Rubinfeld, 2009, p. 108). This assumption may be interpreted in the way that there exists no direct limit to needs. With regard to one and the same good this assumption is not plausible. Therefore, any product innovation is interpreted as the successful invention of new goods for final demand. Corresponding technical change x (τt ) may be seen as the motor of any growth of needs in absolute terms. In general it may represent an increase in the variety of provided to the market. In turn it does not represent any invention of solely intermediate goods. With regard to the model and its aggregate simplifica- tion in analytical terms product innovation may just add new purposes to the representative good, which does not perfectly substitute other purposes.

9 To enjoy all available purposes therefore a higher amount of representa- tive goods are necessary. Although the limit to needs and corresponding demand in absolute terms then does seem far from reached, basic microe- conomics at least also assumes a diminishing marginal rate of substitution – for goods and services as well as for leisure (cf. Pindyck and Rubinfeld, 2009, pp. 113, 693). Following this logic the needs for goods provided by the market may negatively depend on labour supply as it reduces the time available for leisure or at least prevents from considering additional needs for market based consumption goods (see eq. 14).

l  σt  x 1− φ ηt = (1 + τt ) ηt−1 (14)

An important implication of the so far stated assumptions about needs and demand for goods is that product innovation and labour supply cru- cially determine real growth. Growth then is one source driving corporate expectations. In addition one may think of optimistic corporations trying to market their inventions in the hope for an increasing piece of the cake (see eq. 15). Rigidity then determines the final influence of both arguments and somehow refers to a bullish belief in success in spite of maybe unfulfilled expectations of the past.

x θ ξt = Ξτt + (1 − Ξ)gt−1 (15) Any act according to expectations depends on necessary means. To this effect, the growth of money base is assumed to depend on the same variables but with reverse weights on product innovation and consumption growth rate (see eq. 16). It is an implicit assumption about a governmental institution not modelled yet.

+ + x θ mt = mt−1(1 + ((1 − Ξ)τt + Ξgt−1)) (16) While product innovation in the here applied narrow interpretation may trigger needs and expectations and thereby provide the willingness for an l increase in demand and supply, process innovations (τt ) finally allows for productivity gains and thereby real growth for given endowment in terms of labour (see eq. 17). Process innovation as it is interpreted here therefore may also capture the invention and application of new intermediate goods.

l ψt = (1 + τt )ψt−1 (17) To this effect, within the simplified view it still is technological progress that dominantly determines the scope for development of an market econ- omy. Technological progress is what triggers economic change, while the incorporated institutions in terms of routines determine its final effect in terms of wealth.

10 3 Dynamic examination and results

The previous section put forward a highly simplified framework of assump- tions and corresponding equations. The next step now is to apply the deci- sions and interdependencies captured within the set of equations sequentially in discrete time steps to simulate the evolution of the system.

3.1 Timeline of events Applying the equations in discrete time steps means that after a first exoge- nous setup the development of the economy is endogenously determined by a fixed order of procedures:

• technological change occurs, productivity may increase, needs and ex- pectations may grow • wage rate and price of goods adapt according to past market outcomes • dividends are paid out of corporate funds • money base grows and loans may increase corporate funds and debt • labour demand and supply are determined • employment is determined • output is determined and inventories increase • labour costs and income are determined and corporate funds decrease as household funds increase • goods demand and supply are determined • consumption is determined and inventories decrease • sales are determined and corporate funds increase as household funds decrease • profits are determined • savings are determined and deposits may increase as household funds decrease

3.2 Equilibrium versus evolution Discussing a circular flow in a dynamical perspective also raises the question of its beginning. The answer seems rather easy as there has to be something produced to allow for consumption just as income has to be paid before any consumption goods can be sold. To this effect is seems convenient to discuss the circular flow starting with corporate funds (cf. Jaeger and Springler, 2015, p. 303). It can be thought of a giving out tradeable borrower’s notes to trustworthy corporations in order to make the exchange

11 of goods including labour easier as well as more efficient – in line with arguments in favour of money economies (cf. Mishkin, 2004, pp. 44-46). Money then may be seen as the blood in the veins of the market economy’s circular flow. Analysing the money and market economy as a sort of bioeconomic sys- tem the next question refers to stability of this circular flow. One inter- pretation of stability regards to constancy in stocks and flows. The system perspective in mind one may talk about an equilibrium and a very special case of a steady-state solution (cf. Perman et al., 2011, p. 566). Especially Schumpeterian may call this special case the stationary state of the circular flow. It may be seen as a recurrent situation from which the system may be deflected to its next cyclical boom and downturn (cf. Kurz and Sturn, 2012, p. 138). In order to investigate economic dynamics therefore the condition for such statics has to be raised. Focussing the starting point given by corporate funds one condition for constancy in stock and flows simply is: inflows have to match outflows. Following the way of the induced money the discussion may start with the outflows. According to the model outflows are determined by adding up labour costs and dividends. These sources of income determine household funds and thereby finally the upper limit for sales and savings as determi- nants of the potential inflows of corporations. Anything that is expected to flow into corporation funds therefore has to have flown out before. This is easy to imagine for labour costs because costs are directly caused by produc- tion. To treat dividends as necessary expenditures at the time of production, though, may seem confusing. Dividends are determined by past profits and profits in turn are the residual from sales over costs (see eq. 13) – both do not exist in the first round when nothing is produced or sold yet. How- ever, neglecting the existence of dividends in the first round and assuming labour costs as the only source of income would imply that there is also no endogenous scope for profits and dividends in future periods. Aiming at an equilibrium with positive profits the pre-existence of dividends seems to be a necessary condition. It may be argued as the ex-ante reward for risk taking or the provision of not explicitly captured production structures. However, the remaining critical note is that factor distribution somehow is exogenously defined in the beginning. In the same way as there has to be defined an initial distribution of corporate funds among costs and dividends there has to be defined an initial distribution of household funds among expenditures in favour of sales and savings. Neglecting liquidity preference and reserve ratio both channels seem to equally allow household funds to flow to corporations. When savings complement sales to equal the sum of costs and dividends at a constant level, though, deposits and debt may sequentially increase while the real economy does not grow at all (see eq. 12). An alarming but obvious necessity to incorporate an equilibrium in stocks and flows therefore is to assume that

12 there are no savings. All income independent of its source – profit or labour – is consumed and thereby via sales flows back to corporations (see eq. 10, 11). The constant level of economic activity and profits keeps expectations constant too. Constancy of profits as well as sales also necessarily implies constancy of costs. Even in absence of savings therefore there is another condition for constancy in the stock of debt: the absence of and thereby credit costs (see eq. 13). There is no extra money left to pay interest as every money within the circular flow is already created by debt. The only thing that changes is who actually holds the borrower’s notes. In absence of interest this initial debt can always be paid just by these circulating borrower’s notes. The money would flow out as it flew in. For complete constancy, though, it is important that there is no variation of inflows as well as outflows and nothing new challenges the circular flow. To face nothing new also means that there is no change. The absence of technical change is another necessity to allow an equilibrium in stocks and flows in the model. Constancy in stocks and flows over time, though, is not what economists necessarily understand by an equilibrium. The term rather refers to cleared markets and stability of their outcomes (cf. Barro, 2008, p. 178). In this case the desired constancy rather refers to the development of the economy. The development of an economy along a stable path aside any fluctuations still or even more refers to the concept of the steady state (cf. Burda and Wyplosz, 2009, pp. 60-61). Stocks as well as flows then may vary over time and hopefully grow in contrast to the previously sketched situation.

3.3 Product versus process innovation The potential for growth in the model is incorporated via technical change. An important point, though, is that it does so in two separate – even if overlapping – channels. Process innovation as it is adressed here affects productivity and thereby technical production structures, while product in- novation directly affects needs and expectations and thereby final demand (see eq. 17, 14, 15). The model thereby presumes crucial dependencies. If needs of consumers grow faster than the expectations of producers, the of the latter may not suffice in favour of a stable path. Labour supply may continually exceed labour demand (see eq. 8, 6, 7). The wage rate is forced to decrease. Consumers in turn need to increase their labour supply even more in order to hope for the desired level of income. In the absence of corresponding employment, though, income rather decreases as wage rates did in the first place. A lack of effective demand for goods is implied (see eq. 2, 5). A fall in price, consumption, sales and expectations signal the loop downwards at the goods market and in the economy as a whole. A correspondingly set rigidity may provide an exemplary scenario and illustrations of such a vicious circle (see fig. 2, app. tab. 3).

13 Figure 2: Scenario with negative economic growth while needs continually grow (see app. tab. 3)

So far it is the different effect of product innovation on needs and expec- tations that requests to be sensitive. The decision about labour demand, though, not only depends on expectations. It also depends on productivity (see eq. 6). To this effect, the consideration of process innovation alone provides a similar result as before. The increase in productivity provokes corporations to decrease labour demand which, without an immediate and proportional decrease in prices, implies an excess labour supply. Wage rates, later on prices and finally production and consumption find themselves in a loop downwards (see fig. 3, app. tab. 4). Now at the latest it is obvious that the assumption of a labour supply increasing with a decrease of a wage rate bears the expected risk for instability. Any excess supply at the labour market and thereby unemployment triggers stagnation or even . The consideration of product innovation alone does not necessarily pro- vide such an outcome. As long as any growth in needs meets correspondingly high expectations and labour supply does not exceed labour demand, the system seems stable and is able to grow. A side effect in this scenario is the

14 Figure 3: Scenario with negative economic growth while needs remain constant but productivity grows (see app. tab. 4) increase in labour income share to the detriment of profits (see fig. 4, app. tab. 5). This result occurs because the excess of labour demand leads to an increase in wage rates while employment also grows due to the growth in needs and expectations. The potential for real growth then, though, some- how solely lies in an increase in labour supply and thereby is limited by the exogenously set maximum of working time. Production, consumption, labour supply and demand therefore approach asymptotically to a thereby implied limit to growth. It is not a miracle story anyway, if an increase in wealth is achieved by an increase in working time. The glorious story of market economies therefore seems to be based on the right mixture of process and product innovation. An exemplary scenario provides illustrations of exponential growth of pro- duction, consumption as well as wage rates – nominal and real (see fig. 5, app. tab. 6). Despite an increase in real wage rates, though, the labour income share declines due to unequally shared productivity gains.

15 Figure 4: Scenario with asymptotic growth while employment increases due to growing needs (see app. tab. 5)

Finally, as the introduction and its discussion of productivity gains states, the increase in wealth has to be possible even for a decrease of effort. In terms of the model this means that production and consumption may increase despite a decrease of employment (see fig. 6, app. tab. 7). Assum- ing the maximum working time as the starting point indeed forces labour supply and demand to decrease while real wage rates increase and the econ- omy still remains on a fruitful path. Cyclical but exponential growth may be observed. The labour income share, though, still declines to an extent similar to the scenario mentioned before. The decline of the labour income share neither is a specification of the selected method, nor is it surprising (cf. Scheuer, 2015, p. 50). Similar, the possibility for a fruitful decrease of employment is not an utopian result. The introduction to this paper as well as the empirical development of individual working time rather provide a solid foundation for a corresponding claim (cf. Maddison, 2006, p. 347). A threat to employment does not have to be a threat to wealth – on the aggregate.

16 Figure 5: Scenario with exponential growth while employment increases due to growing needs (see app. tab. 6)

4 Completion and disaggregate discussion

At the same time there obviously is scope for the underestimation of the issue. Say’s (1819) law states that every supply creates its own demand and thereby rules out the persistence of any excess supply and involuntary un- employment (Schumann, 2008, p. 110). According to this belief firms would react to cost savings and higher profits due to productivity gains by a cor- responding increase in investment. According to the same logic firms would not have to mind about the implied increase in output: It anyway creates its own demand, re-establishing the equilibrium for market based consumption goods as well. Such an assumption leaves less scope for anticipative and (see eq. 6, 4). It goes beyond the financial logic that the cost of one has to be the income of another and additionally presumes the productive or consumptive use of all income. Although the demand for consumption goods is strongly determined by disposable income, the latter rather acts as a budget constraint. The decision in favour of consumption

17 Figure 6: Scenario with exponential growth while employment decreases (see app. tab. 7) goods provided at the market has to be motivated by needs for those goods in the first place (see eq. 2, 8). While an increase in income may trigger the consideration of so far unconsidered needs, it can not be treated as the one and only determinant of aggregate demand.

4.1 Secular Stagnation Somehow it was a Neoclassical himself that implicitly mentioned this point. Gossen (1854) already recognizes the satisfaction of needs as the fundamen- tal economic motivation. With regard to consumption he adds that beyond the constraint given by income also the constraint given by time matters for the decision of individuals (Kurz, 2008, p. 207). The constraint given by time matters for effective demand at least in two ways. First, market based consumption itself takes time as it is a process itself (cf. Steedman, 2001, pp. 7-20). The individual potential for market based consumption implied by the disposable income therefore may already excel the individually avail- able time. Secondly, also the overlap between the purposes of market based

18 consumption goods and the variety of individual needs is limited. The satis- faction of some needs is not providable by markets but still competes for the available time (see eq. 14). Considering this area of conflict a look on a sim- plified theory of needs like the hierarchy given by Maslow (1943) suggests: while consumption may be related to needs of all levels, it probably suffers some loss of effectivity when it comes to higher levels of needs. This means that the overlap between the purposes of market based consumption goods and the variety of urgent needs rather decreases with the standard of living. Consistent with all these considerations (1935[1964, pp. 31,349]) and economists since then already presume that the propensity to consume within a society decreases with increasing wealth per capita. To this effect and in contrast to the assumption of the model (see eq. 14) even accompanied by a fruitful combination of product and process innovation material needs may approach towards a limit – not only in their growth, but in absolute terms (see fig. 7). Without a corresponding adaptation in the production system a lack of demand seems unavoidable.

income

needs real

time

Figure 7: Exemplary developement of real income and needs satisfiable in terms of available technology and time for consumption

4.2 Unequal distribution Putting the thought forward to the individual level its relevance even seems to increase. Although many textbooks on basic micro- and macroeconomics do not mention this point, it is plausible that the average propensity to con- sume decreases as the income of the household increases (cf. Encyclopedia Britannica). When heterogeneous households strongly differ in their income, distorting effects on both ends of the distribution may occur. On the one side, there may be poor people facing a stagnating income insufficient to satisfy their growing needs. On the other side, there may be rich people with an income at least temporarily outgrowing their needs (see fig. 8).

19 income

needs nominal

households

Figure 8: Exemplary distribution of nominal income and needs for consumption goods temporary considered by households

Both have in common that they bear a threat: a lack of aggregate de- mand – according to Stiglitz (2013, p. 103) the main problem behind today’s depression. A lack of demand therefore may be enforced by an unequal dis- tribution of income and wealth. The distribution of wealth matters not least because it is a more and more important source of income. That the inequality with respect to the distribution of wealth is greater than the inequality of the distribution of labour income is a common regularity in modern economies. It thereby revi- talizes the dicussion about the potential conflict between labour and profit income (cf. Piketty, 2014, pp. 244-245). The more unequal the distribution of wealth is relative to the distribution of labour income, the more relevant is the height of the labour income share in order to prevent the distribution of wealth from greater disparity (cf. Scheuer, 2012, p. 17). The aggregate model does not capture the dimension of personal distribution of wealth and income. It yet is able to discuss the development of labour income share as it differs between labour income based on wages and dividends based on profit (see eq. 9). Thereby it at least implicitly captures the potential for a functional redistribution from labour to capital. The predominance of labour saving and capital augmenting technological progress empirically deposits in the capital intensity of production. Tech- nical change up to now not only increased productivity in terms of output per worker, but also the capital stock applied per worker (Foley and Michl, 1999, pp. 15-17). At the same time the mix of process as well as product innovation for long did not seem to be labour saving in a way that neces- sarily threatens total employment. Besides an increase in leisure time the remaining labour supply rather seemed to be reallocated to other occupa- tions which were partly generated by the innovations themselves (F¨ullsack, 2009, pp. 88-90). To this effect, the potential threat that technical change

20 may bear for labour as a production factor was not considered that relevant, as long the labour income share was not decreasing. However, at the end of the last century labour income share finally deviates from the stylized fact of its constancy (cf. Schneider, 2011, p. 5). So technical change revels its comeback in discussions about distribution. It is a comeback because like many economic challenges also inequality in terms of wages and profits is already discussed by Classical economists. Facing a more and more capital intensive production no less a person than (1849, [2000, pp. 32-42]) warns from increasingly unequal shares of factor incomes accompanied by an excess supply of labour.

4.3 Technological unemployment As mentioned in the introduction, technological progress is very likely to take to form of new capital goods. The challenge that technical change may imply by promoting the substitution of capital for labour was recognized also at the time of the Classical economists already. David Ricardo (1821, [2006, p. 381]) writes with regard to the working class that the increasing use of machinery has detrimental effects at least in the short and medium run. Technological unemployment as a term then refers to the workers displaced due to technological progress and not re-employed immediately again. It captures the thereby determined quantity of labour waiting for reallocation (Gaffard, 2001, p. 1710). To prevent the economy at least from long-term unemployment labour saving technical change has to be accompanied by either a redistribution of wealth and working time or growth. Only real economic growth can re-establish the demand for labour to the extent of its supply and thereby support the maintenance of the past standard of living for the whole group of workers. In the aggregate model above the foundation for such growth is provided by product innovation and correspondingly in- creased needs and expectations (see eq. 14, 15). The mixture of both finally decides about employment while process innovation provides a challenge to it. This challenge and threat implied by unemployment in the modell also crucially depends on the assumption that labour supply decreases with an increasing wage rate (see eq. 8). This intuitively plausible deduction con- tradicts the mainstream assumption that labour supply increases with an increasing wage rate. An assumption that is important to promote trust in a tendency towards a market equilibrium located on a rising supply function intersecting a falling demand function just once (cf. Burda and Wyplosz, 2009, pp. 107-114). Questioning this assumption may imply questioning the stabilizing effect of the labour market.

21 4.4 The worry about wealth Questioning this assumption, however, is neither new nor frowned upon. Even common textbooks discuss the possibility that an increase in a wage rate may cause an income effect that excels the substitution effect (cf. Sny- der and Nicholson, 2008, pp. 575-577). That means that the increase in opportunity costs of leisure due to the higher wage rate may be not able to balance the increase in assigned to any hour of leisure due to risen income. Consistent with the intuitive reasoning of before extended theory already assumes a two times backward bending labour supply function for individuals (cf. Keen, 2004, pp. 119-121). At the upper spectre of wage rates, individuals are able to afford further substitution of leisure for work- ing time – not least in order to enjoy the already higher level of consumption and other charms of life (see fig. 9). Contrary, at the bottom end individ- uals facing low wage rates have to compensate any further decrease in the wage rate by more hours of work in order to afford at least the satisfaction of basic needs. In both cases labour supply (L) negatively depends on the wage rate (w).

norms-based needs-based δL δw ≤ 0

δL δw > 0 wage rate in hours

δL δw ≤ 0

individual labour supply in hours

Figure 9: Exemplary shape of an individual labour supply function reflecting needs in contrast to set norms

Now again technical change comes on the map. Empirically founded eco- nomic theory assumes real wage rates to increase with productivity gains (cf. Acemoglu, 2000, p. 3). With regard to the backward bending labour supply function this once again hints on a potential threat. In a progressing econ- omy some part of workers sooner or later may outgrow the spectre of wage rates where labour supply positively depends on the wage rate. Possibilities

22 and incentives to follow such preference, though, are rather restricted. Wage rates as well as working hours are strongly predetermined by collective bar- gaining (cf. Boeri and van Ours, 2008, pp. 101-108). If the bargained social norms fail to incorporate and enforce the true preferences, individual as well as aggregate labour supply does not truly reflect the society’s needs. Not only the income growth due to technical change but also the forced excess in individual labour supply and thereby generated income then provokes the propensity to consume to fall. This, though, is not the only and probably even not the most acute challenge. Technical change has been seen as one cause for an increasing disparity of wage rates (OECD, 2011, p. 98). To this effect, the technical change triggering increases in wage rates for some types of labour also allows capital to substitute other types of labour. When the sequence of techno- logical shocks does not allow for sufficient recovery to full employment, the bargaining position of workers with qualification profiles similar or lower to those who are proven substitutable by capital remains continually weakened. Unemployment then at least implicitly appears as a workers discipline de- vice holding claims low in negotiations about wage rates (cf. Shapiro and Stiglitz, 1984). The wage rate within such segment then is damned to lack behind in growth or even stagnate. On the aggregate more or less stagnat- ing wage rates as well as the diverse consternation depending on the wage level are empirically found and discussed phenomena (cf. Heathcote, Perri, and Violante, 2010, Mishel, Gould, and Bivens, 2015). A disparity that partly may be caused by disparity itself. Income inequality may imply a decrease of the propensity to consume for higher incomes, a corresponding lack of demand and thereby unemployment in the first place (cf. Stiglitz, 2012, Stiglitz, 2015). A chain of effects that may be triggered sequentially by technical change. The consideration of sequential occurrences of shocks because of inno- vations and a corresponding cyclical behaviour of economies calls another famous economist on the stage. Joseph Schumpeter (1939, p. 102, 1912, p. 159) analyses the ’discontinuous and unharmonious’ evolution due to in- novations as an ’overwhelming fact of capitalistic history’. With regard to the economic system he mentions that innovations and their diffusion take time and require investment in reconstructions of the capital stock (Kurz and Sturn, 2012, p. 175). For good reason therefore the already mentioned John Maynard Keynes considered investment as the second important com- ponent of effective demand in an economy. Investment in capital goods that may depend on savings as a constraint. The incentive for investment is rather assumed to be determined by long-term expectations (cf. Caspari, 2008, p. 172). Expectations that may drop when the economy stagnates and the economy may stagnate as the expectations by firms tend to drop (see eq. 6, 15). Once again the potential for a vicious circle becomes obvious.

23 5 Conclusion

Finally, technological unemployment and unequal distribution do not seem to be necessary conditions for the occurrence of secular stagnation as well as technical change does not necessarily lead to disparity. The multiple in- terdependencies, though, may provide a channel for mutual triggering and enforcement. Taking the discussion of corresponding interdependencies in the economic system as an aim for this paper, the practical ignorance of fi- nancial markets and corresponding incentives for savings and investment in the applied model (see eq. 2 - 17) may be criticized for good reason. Upcom- ing works therefore have to deal with these shortcomings and may extend the approach based on other stock flow consistent models (cf. Caverzasi and Godin, 2015). Already now, though, the investigation contributes some notable features and presumptions:

• economic outcomes are not provided by natural laws, but depend on decisions that are based on evolving needs and expectations • the evolution of needs and expectations crucially depends on technical change • the influence of technical change differs depending on whether it ex- hibits the character of either product innovation or process innovation

Product innovation as a term thereby refers to effects on final demand only, while all effects on the production structure are addressed by the term process innovation. The system graph of private capitalistic production in market economies gives a first impression of the indicated complexity (see fig. 1). Important challenges, though, also lie in the details not sufficiently pictured yet but discussed in the course of completion:

• needs, expectations, decision spaces and finally decisions do not only vary with technical change, but vary differently for different individuals and individual endowments • economic growth combined with disparity may let some consumers become temporary limited in needs while others are limited in means • technical change entering a production system without a correspond- ing redistribution of working time or wealth may cause technological unemployment, unequal distribution and secular stagnation

It is the path dependent heterogeneity in labour qualifications and prop- erty of capital that determines the bitter taste of labour saving and capital augmenting technical change. To incorporate the necessary degree of het- erogeneity into a systemic perspective by the use of agent based models is another task for upcoming papers (cf. Dosi, Fagiolo, and Roventini, 2006 to Dosi et al., 2016).

24 Already now, though, the political reality has to consider that the foun- dation of ideas about a redistribution of working time and wealth are not only to be found in ideology. They rather may be the last chance to preserve the potential of the capitalistic production system when market economies face a certain form and mixture of technological progress as well as natural or artificial limits to growth.

25 Appendix

α savings β household funds γ costs gθ consumption growth rate δx demand for goods δl demand for labour  employment ζ sales η needs θ consumption ι dividends κ corporate funds λ liquidity preference µ income ν reserve ratio ξ expectations o production output π profits ρ price of goods m+ money base σx supply of goods σl supply of labour τ x product innovation τ l process innovation υ loans χ inventory of goods φ maximum working time ψ productivity ω wage rate Ξ rigidity d+ deposits d− debt

Table 1: Variables used in the model

expectations 0 productivity 1.25 moneybase 10 corporate funds 10 sales 10 costs 8 profits 2 dividends 2 demand for labour 8 supply of labour 8 employment 8 production output 10 supply of goods 10 demand for goods 10 consumption 10 inventory 0 needs 10 income 10 wage rate 1 price of goods 1 savings 0 loans 0 deposits 0 debt 0 household funds 0 consumption growth rate τ x

Table 2: Starting values for all scenarios

26 product innovation 0.1 process innovation 0.0 liquidity preference 0.0 reserve ratio 0.0 rigidity 0.1 maximum working time 10

Table 3: Parameter setting for scenario with negative economic growth while needs continually grow

product innovation 0.0 process innovation 0.001 liquidity preference 0.0 reserve ratio 0.0 rigidity 0.9 maximum working time 10

Table 4: Parameter setting for scenario with negative economic growth while needs remain constant but productivity grows

product innovation 0.01 process innovation 0.0 liquidity preference 0.0 reserve ratio 0.0 rigidity 0.9 maximum working time 10

Table 5: Parameter setting for scenario with asymptotic growth while employment increases due to growing needs

product innovation 0.01 process innovation 0.001 liquidity preference 0.0 reserve ratio 0.0 rigidity 0.9 maximum working time 10

Table 6: Parameter setting for scenario with exponential growth while employment increases due to growing needs

product innovation 0.01 process innovation 0.001 liquidity preference 0.0 reserve ratio 0.0 rigidity 0.9 maximum working time 8

Table 7: Parameter setting for scenario with exponential growth while employment decreases

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