Income distribution in advanced capitalist economies

Massimo Pivetti has been central for the development of the so-called monetary theory of distribution, which develops the work of Piero Sraffa. The link (here) is to a talk at UNAM, in México last week (intro in Spanish, but Pivetti gives the talk in English starting at around minute 3). A good paper to follow what he says can be found here. You can see all the videos and other good stuff here.

PS: The classic book on the topic here.

Is the American economy profit-led?

In a recent post I showed the evolution of real wages and long-term real rates of interest in the United States from 1950 until now. The figure below shows the real rate of output (GDP) growth for the same period. Between 1950 and 1973 the average (red line) rate of growth was 4.2% and in the subsequent period it was 2.7%. In other words, the change in income distribution dynamics, with a significant slower rate of growth of wages, was accompanied by a significant reduction in the pace of economic growth (we also saw in the previous post that it also went hand in hand with higher real rates of interest).

Many authors (e.g. the late David Gordon), in particular when looking at the evidence post-1970s, argued that the American economy is profit-led. In other words, as profits (some emphasized profit shares while others prioritized profit rates; the profit rate time the level of capacity utilization gives the profit share) expanded, it stimulated investment, and this, in turn, led to output growth. Growth was driven by profits.

The idea is that, even though the reduction in wages has a negative effect on consumption and output growth, this is more than compensated by the increase in investment. However, there are some empirical problems (there are some theoretical issues that I’ll deal with in another post) with this kind of model (often referred to as Kaleckian, even though it seems that their origin should be traced to Joan Robinson’s Accumulation of Capital and the influential formalization by Bob Rowthorn in the early 1980s).

For starters, growth actually fell significantly after real wages stagnated. Also, the output-to-capital ratio (shown from 1960 to 2008 using a OECD measure), as can be seen in the graph below, does not indicate a marked shift in the 1970s. The output-to-capital ratio goes up in the Johnson and Clinton booms, and falls otherwise. The Reagan boom was mild at best. This is consistent with the accelerator. As the economy moves closer to full employment, the output-to-capital ratio, a proxy for capacity utilization, moves close to its maximum. The accelerator would suggest that investment adjusts capacity to output. Investment is not the locomotive of the system, is the rear car (the idea behind the accelerator principle).

Since the 1970s the drivers of accumulation in the United States have been consumption booms driven by debt accumulation. In other words, as Barba and Pivetti have argued, increasing debt has allowed American families to continue to consume, in spite of stagnated wages. This has been mistaken in the empirical literature as a profit-led boom. The suggestion here is that the booms have continued to be driven by consumption (as in more traditional wage-led cases), and that the benefits for capital have been financial and associated to higher interest rates. The last three booms have been more Wall Street debt-led booms, rather than profit-led investment booms. Wall Street, not the Silicon Valley, defines the current American economy. After all, we all remember Gordon Gekko’s “greed is good” (uttered in real life by Ivan Boesky) and nobody remembers an iconic phrase by Bill Gates!

The ECB is throwing gas on a fire

Professor Massimo Pivetti has recently commented on the European Central Bank's (ECB) interest rate increases, that add monetary contraction to the brutal fiscal adjustment that several countries in the periphery of Europe have been subjected to. He says:

"The ECB increased the rate of interest – in what is very likely the first one of a series of increases expected in the next months – with the objective of controlling inflation that accelerated to 2.6% in March from 2.4% in February. Given that this inflation bout has external origins, caused by the increase in the international price of energy, raw materials and foodstuff, the reasoning behind the anti-inflation policy based on dear money is not immediately obvious.

First of all, according to the currently dominant versions of the orthodox point of view about monetary policy, an increase of the rate of interest by the central bank would be only justified if the reasons for the greater inflation including also monetary wages rises would be attributable to imbalances in the conditions of domestic aggregate demand and supply. But certainly not even Trichet would think that today, within euro-system, aggregate demand is pressing beyond the limits of potential product.

He goes on to argue that the ECB policy is like trying to put out a fire by throwing gasoline on the flames, since higher rates of interest translate into higher costs, which firms would pass to their prices.  He notes correctly that the anti-inflationary impact of this policy comes from the appreciation of the euro, which reduces the cost of imported goods, and the reduced wage pressures from an even more depressed economy.  The rest can be read here (if you read in Italian).