Krugman & Kalecki, “injecting” to escape from a sub-optimal reality
Paul Krugman today wrote that we are in a “Keynesian crisis that calls for Keynesian policies”. Keynesian policies are monetary and fiscal policy to increase demand in the economy.
I wrote a response earlier today about an article from Mark Thoma who called for the same Keynesian policies of monetary and fiscal policies to increase demand. My view is that in normal times, those policies would take us back to a normal real GDP, but since labor share has fallen, the true and natural real GDP now sits at a lower level. If we then use Keynesian policies to push toward a higher real GDP that is above this new lower natural level, we will create an imbalance that could only be maintained by continued “injections” of Keynesian policy. The injections are deficit spending and expansionary monetary policy.
The title of this post implies that the injections are like a drug that lifts us to a “high” in order to escape the dreary, disappointing sub-optimal reality that we live. Economically, we now live in a sub-optimal reality due to a lower labor share of income. (see circular flow model) In order to maintain that “high”, the injections would have to be continued and never stopped. Because if they were to stop, the economy would come down to its true reality. This would cause a recession… like withdrawals from an addiction.
Krugman in his article noted that Michael Kalecki, the famed contemporary of Keynes, “had the answer“. If you mention Kalecki, you know you are going to read something about effective demand. Kalecki worked harder on the idea of effective demand than Keynes in my opinion. My work in economics focuses on effective demand, so I have something to say.
In the Kalecki article that Krugman linked to, we find this written.
“If the government undertakes public investment (e.g. builds schools, hospitals, and highways) or subsidizes mass consumption (by family allowances, reduction of indirect taxation, or subsidies to keep down the prices of necessities), and if, moreover, this expenditure is financed by borrowing and not by taxation (which could affect adversely private investment and consumption), the effective demand for goods and services may be increased up to a point where full employment is achieved.” (source)
This quote is a basic argument for a Keynesian policy of deficit spending to inject demand into the economy. It is important that the government receive its money by borrowing, because an increase in taxes would be a withdrawal from the economy. The increase in taxes would offset or neutralize the effect of the deficit-spending injection.
Does effective demand actually increase with added injections of deficit spending? Yes, as long as it is within the effective demand limit, where effective labor share is still above the product of labor and capital utilization. Can increased injections push the economy beyond the effective demand limit? Yes… but …
Kalecki writes in the link offered by Krugman …
“It may be objected that government expenditure financed by borrowing will cause inflation. To this it may be replied that the effective demand created by the government acts like any other increase in demand. If labour, plants, and foreign raw materials are in ample supply, the increase in demand is met by an increase in production. But if the point of full employment of resources is reached and effective demand continues to increase, prices will rise so as to equilibrate the demand for and the supply of goods and services. (In the state of over-employment of resources such as we witness at present in the war economy, an inflationary rise in prices has been avoided only to the extent to which effective demand for consumer goods has been curtailed by rationing and direct taxation.) It follows that if the government intervention aims at achieving full employment but stops short of increasing effective demand over the full employment mark, there is no need to be afraid of inflation.“
The bolded sentences basically say that if the economy finds full-employment at or under the effective demand limit, prices will equilibrate between supply and demand and inflation will not be a problem. The implication is this… If government expenditure pushes production over the effective demand limit, there will be inflation.
I am here to say that the effective demand limit sits at a real GDP of $16.1 trillion (2009 dollars). That level is dependent upon an effective labor share close to 74%. By my calculations, at that level of real GDP, unemployment will come down to between 6.7% and 7.0%, which is not full-employment in the eyes of Krugman, Thoma and many others. They will want to push real GDP beyond $16.1 trillion with more injections… toward the CBO potential real GDP near $17 trillion. The result will be lower unemployment with inflation. Then everyone on the right in economics will accuse them of causing inflation just like “typical” Keynesians. The right will accuse them of taking the economy back to the 1960s. Hippie drugs and all.
Even if there is no inflation from pushing real GDP over the effective demand limit, which is a possibility, the economy would still want to lower real GDP back down to the effective demand limit. There are mechanisms of the profit rate that make that happen. Kalecki and Keynes wrote about that. Thus to maintain the induced “high” of a higher real GDP, the injections would have to be maintained and probably even increased over time. At some point in time, the pressure to stop the injections would mount, the injections would decrease and the economy not being able to maintain the artifical “high” real GDP on its own, would fall into recession.
Kalecki had an advantage over Krugman, Thoma and others. He was keenly focusing his awareness on the effective demand limit, even though he did not have a clear way to predict it. I work on an equation that can predict the effective demand limit. Krugman, Thoma and others need to be aware of the effective demand limit. Without this awareness, their policies will create a drug-induced high that will only lead to a harsher crash back to reality in the future.
They really should be talking about ways to increase the effective demand limit to protect us from inflation and other problems. The only way to do this is to raise labor’s share of income. I don’t see them giving any ideas on this over the past 2 days.
I haven’t been abe to keep up with your postings even though I find them very intriguing. That is to say, I can read through them, but not have time to digest it all.
Krugman insists that we are still stuck where inflation can’t occur. he has said that just giving people money would help. Just giving people money would increase labor share, would it not?
Krugman, Thoma, et al really push on infrastructure spending – items with high multipliers. Is a high multiplier congruent with an increasing labor share?
I have observed the importance of labor share by turning the Libertarian trajedy of the commons to its corporate analog. Consumers are the common resource of all businesses, so it is important to business that consumers have lots of money. But consumers are the business’ workers and each indiviual business will seek to pay its workers as little as possible even though it damages the common pool of consumers.
I also think that we can apply something like the Laffer curve. (Sadly, the observation that things are not linear does not seem to be a takeaway by many people as they argue about the endpoints.) Near zero labor share increasing labor share obviously increases demand that can be met. Near 100 percent labor share, decreasing labor share allows the increase in capital to lead to an increase in production for which there is demand. Somewhere in the middle there is a point where the derivative is zero and supply and demand will be insensitive to labor share. I believe this is an equilibrium for supply=demand, but that it is entirely contrary to your models.
I am trying to see if this fits together, but my lunch time is over.
i am not sure that taxing people to fund government projects that give real work to other people will hurt demand in the way you expect. It depends on what the people with the money were doing with it before you raised their tax.
Your model seems to assume they were spending it all, or “investing” it (presumably in something more productive than playing financial games).
You make a good point. The type of tax would make a difference. The basic idea is to tax activities with negative externalities. The goal is to have a price and cost structure that satisfies an equilibrium between marginal social benefits and marginal social costs.
for example, take the financial transaction tax, would such a tax calm down the volatility that adversely affects producers and consumers? Then would that tax money be better spent on employing labor? You would say yes. I would agree.
I think Edward’s model suggests that government job creation that’s achieved by taxing capital is just what we need. Labor share increases both by job creation and from shrinking capital share , and no new debt is required.
Good luck getting Congress to buy in , though……
If we transfer labor income from the rich to lower incomes, labor share would not change. We would have to transfer money from capital income to labor.
How would that look in the circular flow model? Corporations are taxed more. That money goes to the government. The government then injects that money into the consumption side where labor is consuming. The labor share percentage of national income itself would not change, but the transfer would simulate a rise in labor income.
You make a good point about the multiplier of infrastructure projects. If the money multiplier is being suppressed by low labor share, then it can partly be offset with projects that raise the money multiplier.
I have a post that answers your insight into whether there is a perfect level of labor share. Here is the link…
The post says that back in the 60s, labor share was a bit too high. Now it is way too low and we see the opposite consequences.
Have you heard of the “Moniac” economic model , put together in the ’40’s by Bill Phillips , of Phillips Curve fame ? It really makes the circular flow analogy easy to grasp for non-economists , and I could see how your model could be visualized similarly , though I don’t have a clue how you’d go about constructing the graphics :
Here’s a virtual Moniac :
More info :
My God Marko, that is awesome. A person could learn so much by just sitting there and watching for a couple of hours. Totally awesome! Is there a video that shows it in action?
I found two videos for the Moniac…
Here’s a full-length version of one you linked above :
If I tried to produce such a model , it would come out looking something like this :
That is an interesting model. Thank you for showing it to us.
Michael Kalecki was probably the first to propose a theory of the aggregate income distribution hinging on the determinants of firms’ market power. In particular:
(1938): ”The Determinants of the Distribution of National Income”, Econometrica, 6, 97-112.
(1954): Theory of Economic Dynamics, George Allen and
The literature on price determination shows that firms’ markups depend on factors like industry concentration, collusion, demand elasticity, and the potential entry of other firms into a market. Most changes in these variables are uncorrelated across industries. Nonetheless, they are simultaneously affected by the business cycle. Hence the business cycle is an important determinant of profit margins. Furthermore, markups also depend on labor’s bargaining power (see Kalecki, 1954). Since higher unemployment is likely to decrease both union’s bargaining power and the substitutability of employment by wages, unemployment constitutes a significant determinant of markups. In particular, markups are a positive function of the unemployment rate.
And in fact this is what the more recent literature on the subject concludes (Page 3):
“I begin with three well-known explanations of labor share or its inverse. The overhead labor-wages lag hypothesis long identified with Sherman (1972, 1997) makes labor share a function of capacity utilization. The depletion of the reserve army theory hypothesis closely identified with Boddy and Crotty (1975) makes labor share a function of unemployment. The markup theories of Goldstein (1986, 1996) make the inverse of labor share a function of unemployment and capacity utilization. Since Goldstein’s views on the impact of unemployment are along the lines of Boddy and Crotty, it is his theory on the impact of capacity utilization that is of concern here. I begin with Boddy and Crotty on the role of unemployment and then turn to the contributions of Goldstein and Sherman on the role of capacity utilization.
Unemployment and the Strength of Labor
Boddy and Crotty focused on the increase in labor share in the second part of the expansion as the outcome of the rising strength of labor. Declining rates of unemployment increase labor share by increasing product real wages for given levels of labor productivity. According to Boddy and Crotty the depletion of the reserve army can also directly affect labor productivity.
Although Boddy and Crotty (1975) carried out the analysis in the Burns Mitchell NBER cyclical stages framework and not with econometrics, we argued—presciently for my purposes in the present paper– that the confidence of labor would depend both on the level of unemployment and on the change of unemployment. Most workers are not directly affected by bouts of unemployment. Their confidence should be high when the rate of unemployment is low but confidence should also be affected positively if the rate of unemployment is decreasing. Based on the above arguments, I assume that the change in labor share depends on both the rate of change of unemployment and its level. It is crucial to understand the implications of the inclusion of the level of unemployment as a determinant of the change in labor share. Suppose that the rate of unemployment is extremely low but unchanging. In the absence of the level of unemployment the prediction would be that labor share would remain constant. With the inclusion of the level of unemployment the prediction becomes that labor share would continue to rise.”
And should there be any doubt whether unemployment causes labor share, or labor share causes unemployment, it’s a relatively simple exercise, given an econometric software package, to confirm that the unemployment rate Granger Causes labor share of factor income, but labor share of factor income does not Granger Cause unemployment.
So the question then becomes, what determines unemployment? Well the level of aggregate demand of course.
1) Aggregate demand (AD) is the total demand for final goods and services in the economy at a given time and price level.
2) Aggregate supply (AS) is the total amount of goods and services that firms are willing to sell at a given price level in an economy.
The AD-AS model is almost always represented graphically:
The intersection of AD and AS determines the price level and the level of real output. The level of employment is a function of the level of output. (Keynes repeatedly refers to the relationship between output and employment in The General Theory.) And the unemployment rate is simply the precentage of the labor force that is not employed.
Thus, as Adair Turner recently pointed out in his speech on Overt Monetary Finance (OMF) (see Slide 21):
1) Fiscal and monetary policy determine AD (which is equal to nominal GDP or NGDP).
2) And AD determines prices and real output.
Compensation of Employees reached its peak share (67.7%) of National Income in 1980:
And that happens to be the peak year for inflation as well. Coincidence?
The labor share of income during the age of disinflation has declined pretty much everywhere in the advanced world.
Peak Core CPI Rate*, Peak and Recent Labor Share of Income (Total Economy) (*Except Portugal)
The international labor share data comes from the OECD and is not consistent with BEA data:
Select *Total Economy*.
Although there are many reasons for the increase in inequality that we have seen in the US and in other parts of the world (regressive taxation, weaker unions, lower minimum wages, globalization, Skills-Based-Technological-Change (SBTC) etc.) the leading hypothesis for why there has been such large scale declines in the labor share of factor income is disinflation (i.e. tight monetary policy).
Disinflation during the eighties and the nineties was accompanied by a significant rise in the profit share of national income in most OECD countries or, equivalently, by a reduction in the labor share. This suggests that changes in the rate of inflation are non-neutral with respect to the distribution of factor income. The consequences of inflation upon inequality thus may largely be the indirect result of the effects of inflation upon factor shares. The mechanism by which this comes about is fairly simple. Accelerating inflation is correlated to falling unemployment rates, falling unemployment rates lead to greater labor bargaining power, and greater labor bargaining power is correlated with lower markups. Furthermore, higher inflation rates create greater price dispersion leading to greater competition among producers to limit markups. This hypothesis was tested with a panel of 15 OECD countries over the period from 1960 to 2000 and a robust positive relationship between inflation and the labor share was obtained:
Inflation and Factor Shares
Francisco Alcalá and F. Israel Sanchoy
“We use results from the literature on the determinants of price-cost margins to derive an equation relating labor’s share of national income to the inflation rate (as well as to the output gap, the unemployment rate and the capital stock per worker). The equation is tested with a panel of 15 OECD countries. We obtain a robust positive relationship between inflation and the labor share. Our results suggest that disinflation is not distributively neutral, provide empirical support for the distinct concern about price stability shown by trade unions and employers’ organizations, and help explaining the negative impact of inflation on growth.”
“Hippie drugs and all.”
“Thus to maintain the induced “high” of a higher real GDP, the injections would have to be maintained and probably even increased over time. At some point in time, the pressure to stop the injections would mount, the injections would decrease and the economy not being able to maintain the artifical “high” real GDP on its own, would fall into recession.”
“Without this awareness, their policies will create a drug-induced high that will only lead to a harsher crash back to reality in the future.”
Based on my readings of Kalecki (and Keynes for that matter), I personally think he would be appalled by you comparing aggregate demand management to drug use. Kalecki spent the better part of his life trying to convince people that macroeconomic stabilization policy was the responsibility of the state.
I’m used to seeing such analogies made by right wing commenters, but I have to say this is the first time I’ve seen a blogger on a supposedly “left of center” blog comparing aggregate demand management to drug use.
Check out this paper…
It doesn’t lead to many conclusions other than there is a cyclical pattern between capacity utilization and labor share. That is the basis of effective demand.
The upper bound of that cycle is determined by employment.
So in this sense, unemployment causes labor share. This agrees with what you say.
But look at what Kalecki wrote at the end of that quote in the article. It is bolded.
Kalecki is saying that full-employment can exist beyond effective demand. This is what Keynes said in that the economy can get stuck in an equilibrium below full-employment. (demand constrained equilibrium)
Since effective demand is determined by labor share (we see this in the circular flow model) labor share will affect the limit of employment through a lower equilibrium level of GDP.
Employment can be pushed beyond that limit by other factors that directly influence production and employment, but the result will be inflation. Much of what you wrote above describes this. So at that critical upper bound of the “labor share-capacity utilization” cycle, labor share has an influence over employment.
but when the economy moves at a distance from effective demand, labor share does not influence employment. I think that agrees with what you say.
It’s like in the AS-AD model, yes we have price level on the y-axis, but the price level doesn’t really come into play until real GDP hits the LRAS curve, which is the effective demand limit. Up until that time, price level isn’t a particularly important player in the dynamics of real GDP. It would be like putting labor share on the y-axis and employment on the x-axis. As the economy recovers, employment increases due to other factors, and then at the LRAS curve (effective demand limit) labor share will start to rise. This agrees with what you said above, “Boddy and Crotty focused on the increase in labor share in the second part of the expansion as the outcome of the rising strength of labor. Declining rates of unemployment increase labor share by increasing product real wages for given levels of labor productivity.”
You give good information above. Some others view financialization as the main cause of the decline in labor share. That may tie in with disinflation through monetary policy and banking policy.
It does sound strange then to compare Keynesian policies to drug use. But remember that Kalecki died in 1970, a time when full-employment was much more easily reached within the effective demand limit. Kalecki would have a different view today.
But I am no right-winger. I am using the views of Keynes and Kalecki to show that full-employment is now beyond the equilibrium level of real GDP (LRAS curve).
And you must know the result if you push a market beyond its equilibrium point. It will want to come back to it.
I am pointing out something extremely Keynes, namely the effective demand limit. Krugman and others simply don’t have a useful grasp of this concept. You will not find it in many books. Aggregate demand is used, and there is no distinction to what effective demand is. There hasn’t been a good equation for it. I have a new one that is working so far.
So I am being very left of center, because I am using effective demand. And I have an insight into how to use it. A good method apparently hasn’t been developed yet, even though there are glimpses of similar work decades ago.
I am not Krugman’s enemy or competitor. I am on his side. Yet, I see a weakness in his argument. There is a hole where effective demand should be. And if he is not aware of it, he will be confused later on. i don’t want that to happen to him.
Remember that I wrote in another article about Krugman, I have faith that when he is aware of effective demand, he will not get it wrong. That should tell you right there, I am on his side. I trust his judgement once he has a model that makes sense in front of the eyes. i just don’t see any talk of effective demand coming out of his writings. And if he really is a Keynesian left of center, he had better get on board with effective demand.
“But look at what Kalecki wrote at the end of that quote in the article. It is bolded. Kalecki is saying that full-employment can exist beyond effective demand.”
I assume you mean this quote:
“It follows that if the government intervention aims at achieving full employment but stops short of increasing effective demand over the full employment mark, there is no need to be afraid of inflation.“
I think it’s quite clear from the quote that Kalecki views effective demand as a *variable* that is completely under the control of the government, not as some fixed constraint which you apparently conceive it as. Thus, in order to achieve full employment without inflation, Kalecki is saying that all the government needs to do is simply raise effective demand until full employment is achieved and no further.
“It’s like in the AS-AD model, yes we have price level on the y-axis, but the price level doesn’t really come into play until real GDP hits the LRAS curve, which is the effective demand limit.”
“As the economy recovers, employment increases due to other factors, and then at the LRAS curve (effective demand limit) labor share will start to rise.”
Effective Demand in the sense that Keynes (and Kalecki) meant it has absolutely nothing to do with the LRAS curve.
The notion of a vertical long run supply curve (LRAS) really did not come into existence until the 1970s largely under the influence of Monetarists and New Classical economists. However it is clear that Keynes (and Kalecki) thought there was a vertical portion of the AS curve at full employment.But even this has nothing to do with Effective Demand.
“I am pointing out something extremely Keynes, namely the effective demand limit. Krugman and others simply don’t have a useful grasp of this concept. You will not find it in many books. Aggregate demand is used, and there is no distinction to what effective demand is. There hasn’t been a good equation for it. I have a new one that is working so far.”
Keynes defines Effective Demand in Chapter 3 of The General Theory:
“Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z = (N), which can be called the aggregate supply function. Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D = f(N), which can be called the aggregate demand function.
Now if for a given value of N the expected proceeds are greater than the aggregate supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to increase employment beyond N and, if necessary, to raise costs by competing with one another for the factors of production, up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs’ expectation of profits will be maximised. The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand.”
In other words Effective Demand is simply the point where AD and AS intersect. To be excruciatingly clear, Effective Demand is the price level and real output level that correspond to the point where AD and AS intersect.
The reason why most books do not use the term is there is already plenty of terminology to teach students in a course on introductory macroeconomics. A special term just for a point of intersection is not really necessary.
In any case, whatever you mean by the term “Effective Demand”, it is clearly not the same as what Keynes or Kalecki meant.
“Some others view financialization as the main cause of the decline in labor share. That may tie in with disinflation through monetary policy and banking policy.”
I’ve seen speculation to that effect. But the problem is that financialization has been increasing steadily since before WW II in the US, and the labor share of income has only been declining since 1980.
Thomas Philippon devised a measure of financialization of the economy which involved taking the ratio of compensation of employees in the financial and insurance sectors to total compensation in the economy. You can see a graph of this measure in Figure 1 on Page 7 of his paper “Has the Finance Industry Become Less Efficient?”:
Now, what I’ve done is graph that very same measure (blue line) along side the labor share (red line) since 1948:
Notice that labor share rose until 1980 and has fallen since but financialization more or less increased steadily throughout.(In fact the correlation is significantly positive although I don’t think it is meaningful.)
Besides, there’s a lot more to the monetary transmission mechanism (MTM) than simply the Bank Lending Channel.
The largest surge in Finalization came from 1990 onward which coincides with the demise of Section 20 of Glass-Steagall and the eventual repeal of Glass-Steagall. Commercial Banks could now engage Wall Street with investments in MBS/CDO, CDS, naked CDS. Up to that point they were tied to some rather mundane stuff.
“From 1990 to 2006, the GDP share of the financial sector in the broad sense increased in the United States from 23% to 31%, or by 8 percentage points.” http://www.bis.org/speeches/sp081119.htm
Further on down the same report, Mr. Mr Már Gudmundsson, Deputy Head of the Monetary and Economic Department of the BIS makes this statement concerning the percent of corporate profits resulting from Banking Services (not tellers):
“The figures on profits are even more striking. For example, the financial services industry’s share of corporate profits in the United States was around 10% in the early 1980s but peaked at 40% last year.”
I would conclude the shift of profits resulting from Financialization have been rather spectacular in the shorter term or the last couple of decades.
I wish you luck. As a non-economist it seems intuitively obvious that the concentration of wealth has to be problematic in a consumer driven economy. Here is an intellectual framework to explain why. The vast majority of the population and hence consumers are classified as labor. And if their share of GDP is falling this means that the concentration of wealth is in effect starving the engine of the economy. This would seem to obvious on its face. Yet I continually hear very bright people saying that there is no evidence that the concentration of wealth is having this negative effect on economic performance. If the models we are working with can’t get this fundamental relationship right it seems to me that they are really lacking in coherence regarding the big picture.
I applaud what you are doing, and I think you may be headed in the right direction. I recently changed ‘are’ to “may be” because I think I see a reliance on a “model” and “what he said.”
Let me modestly suggest that you check your thinking from time to time by saying… what has the model overlooked? what did “he” overlook.
One thing occurs to me right off the surface that may not be at all important… but when you talk about “labor share” you are including as “labor” some rather highly paid people, whose consumption habits might not be much different from that of people who get their income from “capital” (which in turn may or may not have anything to do with “consuming” (that is purchacing) capital goods.
Don’t fall in love with your model.
“One thing occurs to me right off the surface that may not be at all important… but when you talk about “labor share” you are including as “labor” some rather highly paid people, whose consumption habits might not be much different from that of people who get their income from “capital” (which in turn may or may not have anything to do with “consuming” (that is purchasing) capital goods.”
That’s a very interesting comment in light of Kalecki’s “The Determinants of the Distribution of National Income.” If you read the paper you’ll note he explicitly went to the trouble of excluding non-manual labor from his measure of labor share precisely for the reasons you give. I haven’t noticed anybody since him do the same.
I don’t mean to be difficult…
“manual labor” troubles me. I don’t know that we have that many manual labor jobs left… not enough anyway. And I am a little unsure about an old left that worships manual labor (i am not even sure there was such, but it seems to me there was/is).
When I worked as a surveyor they were never sure if i was a manual laborer so they could pay me less, and despise me while they were at it (“they” here is the manager, engineer class), and if I was, why did they have to come to me for all the actual numerical answers they needed?)
But for current purposes, the problem is I still don’t know who you are talking about, or why.
“But for current purposes, the problem is I still don’t know who you are talking about, or why.”
Why does the labor share of factor income matter?
There’s really only three main sources of private personal income from the production of goods and services (i.e. GDP): 1) labor compensation, 2) proprietor and 3) capital. (Capital gains is really income from a realized asset appreciation.) Capital income consists of dividends, interest and rent. Labor compensation is the most equitably distributed source of income, and capital income the least.
To give you an idea of how equitably distributed the three sources of income are, consider the sources of adjusted gross income (AGI) excluding capital gains for taxable units in the 90th-95th percentile in AGI (Between $127,000 and $208,000), and those in the 99.99th percentile (over $5.9 million) in 2011. (All data comes from Emmanuel Saez.)
Those in the 90th-95th percentile earned 91.1% from labor compensation, 5.6% from proprietorship and 3.3% from capital. Those in the 99.99th percentile earned 39.6% from labor compensation, 35.7% from proprietorship and 24.7% from capital. If we had data for those lower down in the income distribution it would show an even greater dependence on labor compensation as a source of income.
Simply because labor compensation is the most equitably distributed form of income, a decreasing share of labor compensation means there will be an increase in income inequality.
Why not Google the Tax Policy Center. It has the breakdown from top to bottom. Partial 2011 data is as follows:
99.7% or the top 3 tenths of 1%: making >$1,000,000 ~433,000 household tax units
Labor Income: 24.5%
Business Income: 23.7%
Capital Income: 41.9%
Other Income: 9.9%
the bottom 14.9% making <$10,000 ~$24,457,000 household tax units Labor Income: 56.6% Business Income: 2.7% Capital Income: 2.6% Other Income: 38.1% Other Income = SS, Pensions, VA, etc.
this is difficult because I think I agree with you. But the statistics you cite don’t, i think, make any case at all.
if Lambert has shown that when the share of income to labor falls below a certain percent, the economy does poorly, i would not be surprised. but if he can show a reliable numerical relationship, that may interest policy makers…
i don’t think it matters after that that incomes are “equitable.” that may be the cause of the phenomenon, but it needs to be broken down better, or explained… because those top one tenth of one percent of “earners” getting 30% of their income from “labor” suggests to me that the “labor share” may not be the operative factor. “inequality” might be, though even there i would prefer to be shown the cause-effect, even statistically, because I don’t think it’s healthy to simply hate the rich. some of them are useful, and some of them may actually in some way “earn” their pay.
i don’t say that they are, or that they do, only that painting with a broad brush leads to bad science and worse politics.
and if we are talking about “manual labor” we may be looking at a real problem that is not going to get better soon, and should not be “made” better by simple tax transfers or refusing to use labor saving machines. personally i have no trouble with paying “manual labor” the same rate per hour as engineers or “managers.” but try it and you’ll find out just how “liberal” your friends are.
are we still talking about the same subject?
what i am afraid of is
economists talk themselves into a level of generalization and abstraction which becomes reality to them, and they recommend polices based on them, to hell with real people.
which is why the policies never work.
(except maybe new deal keynesianism… which seemed to me did work until vietnam and the oil shocks and maybe “tax cuts for every reason” brought in new policies that only looked keynesian while the Fed pursued a policy that was monetarist beyond reason.
note, i don’t entirely know what i am talking about here. trying to provoke those who do to make their cases more clearly.
“The largest surge in Finacialization came from 1990 onward which coincides with the demise of Section 20 of Glass-Steagall and the eventual repeal of Glass-Steagall. Commercial Banks could now engage Wall Street with investments in MBS/CDO, CDS, naked CDS. Up to that point they were tied to some rather mundane stuff.”
[“From 1990 to 2006, the GDP share of the financial sector in the broad sense increased in the United States from 23% to 31%, or by 8 percentage points.” ]
The measure that Gudmundsson is using is a System of National Accounts (SNA) measure which the BEA does not produce. It includes financial intermediation, real estate, renting and business activities.You can get it from the OECD here:
Unfortunately it only goes back to 1970. Here it is as a percent of GDP:
This measure of the financial sector grew in real terms at an average rate of 5.8% compared to 3.5% for GDP as a whole. In contrast it grew by 5.0% from 1990 to 2006 compared to 3.1% for GDP as a whole. In other words even by this extremely broad measure the trend was as fast before 1990 as has been since.
FRED has measures of financial sector GDP that comes from the Flow of Funds which is more consistent with Phillipon’s measure of financialization. Here’s gross value added of the financial corporate sector (blue) and of the financial business sector (red):
Note that the broader of these two measures includes partnerships and sole proprietorships and only goes back to 1960. The narrower measure goes all the way back to 1947. Note also that the trend is upward throughout with the corporate measure rising from 2.0% of GDP in 1947Q4 to 7.6% in 2006Q2 (the business measure reaches 8.6% the same quarter).
[“The figures on profits are even more striking. For example, the financial services industry’s share of corporate profits in the United States was around 10% in the early 1980s but peaked at 40% last year.” ]
Here is financial sector profit share at a quarterly frequency:
Note that it is a lot more volatile than the GDP share. Gudmundsson is right that the share reached a low of only 10.3% in 1982Q1 but that was during the relatively severe 1981-82 recession. It had been as high as 22.1% in 1970Q1. But if one ignores the cyclical volatility one will notice a more or less steady upward trend rising from 7.6% in 1948Q1 to 40.6% in 2001Q4. (Gudmundsson’s figure is correct but the peak occured much earlier than 2007.)
And on an annual basis the data goes back to 1929. (The following graph only goes back to 1934 for the simple reason that financial sector lost money in 1932-33 and it shows up as a huge outlier.):
Note that financial sector profit sector share reached a low of 5.3% in 1943.
“I would conclude the shift of profits resulting from Financialization have been rather spectacular in the shorter term or the last couple of decades.”
Actually I think its clear that for data that reaches all the way back to WW II you see a steady upward trend since then with the exception of the profit share data which is of course shows a much more volatile rise.
Excuse my simplistic mind:
1970 = 16.6
1990 = 23.0
1990 = 23.0
2008 = 31.2
1990 = 23.0
2006 = 30.8
So which measure is right? 1 or 2% is pretty dramatic.
In either case and using the numbers as taken from the report, the numbers reflect a higher growth since 1990 to either 2006 or 2008. It would seem logical there would be greater finacialization from 1990 onward given the increasing percentages of gross profits allowed commerical banks to invest on Wall Street. I believe it was in 2003 Greenspan signaled the market he was not going to increase Fed Rates. This came at a time when foreign investors were looking for safe haven. The next logical and safe place was mortgages. Couple this with the lossening of mortgages allowing people to withdraw equity for anything. There was an influx of domestic and foreign monet coming into Wall Street and banks. It would makes sense for a higher growth in that time period and a greater financialization of the economy.
“This measure of the financial sector grew in real terms at an average rate of 5.8% compared to 3.5% for GDP as a whole.”
“This measure of the financial sector grew in real terms at an average rate of 5.8% from 1975 to 1990 compared to 3.5% for GDP as a whole.”
“Mark: Why not Google the Tax Policy Center. It has the breakdown from top to bottom…”
Thanks. I did not know that TPC had breakdowns by type of income.
Let me put this as simply as I can.
I don’t agree with Edward that there is a threshold below which if labor share falls fiscal and monetary policy becomes ineffective. I have told him previously that I believe that there are serious problems with his work and he has not addressed these problems to my satisfaction.
On the other hand I believe that the 30+ year trend of rising income inequality is a serious socioeconomic problem and a significant proportion of that problem (Lawrence Mishel estimates nearly 30%) is due to falling labor share of factor income. In addition I believe that tight monetary policy has been responsible for the great majority (say about 80%) of that decline.
Does that help?
I agree with you. I was just trying to get you to make the case.
Interesting piece Mr. Lambert. The implications are rather unsettling. Basically this is the opposite of Kennedy’s talk of the rising tide that lifts all boats.
Essentially you’re saying that we can’t ”grow the pie bigger’ but can only distribute it in a more equitable way. Even if this were true this would exacerbate social conflict-as the medicine would be understood as taking money business and richer taxpayers and giving it to the rest of us.. Don’t get me wrong, in principle I support a more equitable distribution of income.
However, if we can’t also at the same time grow the pie bigger too-if we can only change its distribution, a good chunk of the population has to suffer a net loss. This would make the political will to fix the economy even worse than it is now when the assumption is that the way to fix it is to grow the pie larger.
Edward does not say such in my opinion. What he is saying there must be certain inputs in order to grow the pie bigger.
I somewhat despair of people ever making sense to each other. But I don’t think Lambert was implying that at all. At least I hope not, though I would have to admit that some of his, and other’s, remarks could seem to imply that’s where they’d start.
I think that what he is saying, and what should work if the left and the right can ever agree to just get along, is that raising the wages of ordinary workers will lead them to consume more which will lead those who have money to invest to invest it in new businesses and new products which will grow the size of the pie.
He is saying that at some level (some precise level apparently) when the share of compensation to labor (including highly paid labor, also apparently, but maybe only because he hasn’t teased it out yet) falls below that percent of GDP, there isn’t enough “consumption” for business to be willing to invest. Sounds good to me, but like you, i hate to see the left go crazy with some scheme to eliminate automation or to just tax the rich to pay some kind of transfer (welfare) to workers. That won’t work politically in this country, and probably won’t work “economically” in any country. Just as people get tired of working for pennies while the bosses make millions, workers get tired of working while other workers slack off and still get paid the same.
I think the key here is to learn to distinguish between the predatory rich and the reasonable rich. They all should pay taxes according to ability to pay… within reason (my reason), but the reasonable rich don’t like to see themselves called “evil” and threatened with confiscatory taxes. Meanwhile the workers need a fair (llving) wage, and good jobs.
“In either case and using the numbers as taken from the report, the numbers reflect a higher growth since 1990 to either 2006 or 2008. It would seem logical there would be greater financialization from 1990 onward given the increasing percentages of gross profits allowed commerical banks to invest on Wall Street.”
Arithmetically sure, but not geometrically.
Let’s divide it into pre and post 1990 and use nice round 20 year periods. Real GDP was $4,494 billion, $8,603 billion and $14,248 billion in 1970, 1990 and 2010 respectively. The real GDP of the financial sector was $744 billion, $1,975 billion and $4,456 billion in 1970, 1990 and 2010 respectively. Real GDP excluding the financial sector was $3,750 billion, $6,628 billion and $9,792 billion in 1970, 1990 and 2010 respectively.
The average rate of growth of real GDP from 1970 to 1990 was 3.3% and from 1990 to 2010 was 2.6%. The average rate of growth of the real GDP of the financial sector was 5.0% from 1970 to 1990 and 4.2% from 1990 to 2010. The average rate of growth of real GDP excluding the financial sector was 2.9% from 1970 to 1990 and was 2.0% from 1990 to 2010.
Thus the financial sector grew at a rate 1.7 points faster than real GDP from 1970 to 1990 and at a rate 1.6 points faster than real GDP from 1990 to 2010. When compared to real GDP excluding the financial sector it grew at an average rate 2.1 points faster from 1970 to 1990 and 2.2 points faster from 1990 to 2010.
Thus I don’t see how anyone can honestly look at that data and conclude that there was a change in the relative growth of the financial sector after 1990. And the other data shows that the trend towards greater financialization has been at a more or less steady pace all the way back to WW II.
“I believe it was in 2003 Greenspan signaled the market he was not going to increase Fed Rates. This came at a time when foreign investors were looking for safe haven. The next logical and safe place was mortgages. Couple this with the loosening of mortgages allowing people to withdraw equity for anything. There was an influx of domestic and foreign money coming into Wall Street and banks. It would makes sense for a higher growth in that time period and a greater financialization of the economy.”
Yes, but look at the numbers. Does any of our several measures of financialization show an increase in the trend towards greater financialization after 2003?
The broad SNA measure of financial sector GDP shows it had a 30.4% share in 2003. The highest level it has been since then is 31.4% in 2009. If anything that looks like a decrease in the rate of relative growth, not an increase.
There was an increase in the Philippon measure of financialization from 7.2% in 2003 to 7.8% in 2007. The gross value added of the financial business sector rose from 8.0% of GDP in 2003 to 8.6% of GDP in 2006. But both are pretty much in line with the historical trends.
The financial sector profit share was 34.4% in 2003 and has been lower, not higher, ever since.
None of the data appears to agree with that theory, does it?
” Just as people get tired of working for pennies while the bosses make millions, workers get tired of working while other workers slack off and still get paid the same.”
It’s hard to understand from where, or why, this trope regarding slack workers keeps popping up. Worse yet that it should be repeated on this “Slightly left of center economic commentary on news, politics and the economy. ” What group of workers is it that is getting paid for their slacking off? What group of workers is even being paid a fair wage for the work that they actually perform? Yes, the banking and finance industries are paying some of their executive class a handsome compensation for some very questionable behavior, but I’d guess that those are not the workers who are being referred to when the slacking off description is being applied. So please tell me which group of workers are being paid for slacking off. I’d like such a position now that I’m getting ready to stop working at all.
What ails the working class is not undeserved compensation. Nor do workers suffer from too much pay for substandard work, whether measured in time or quality. What ails workers is the lack of work that pays a decent salary/hourly wage. What ails workers is the lack of full time work opportunity. What ails workers is the expatriation of industry and the better paying jobs associated with such displacement of production. I don’t know of, nor have I read about, those workers who are asking for or receiving wages in exchange for gold bricks. Please point them out to me. Or if you can’t identify who they are or which industries they work in then please drop the asinine reference to workers who get too much for doing too little. That’s a damned fairy tale.
Coherly and Run. Thanks for your input. Maybe I don’t have what he was saying right then. I was just saying that if the only thing that can be done is redstricbute GDP-rather than grow it, it will be a tough sell.
I do agree that the percentage of GDP going to workers has been dropping and that’s a real problem. Still, Lambert here seemed to be very specific about how much GDP we can get before there’s no slack left in the economy-$16.1 trillion. In a way you’d have to give him real props if he somehow is able to calculate the point of zero slack so effectivly. Still the implication then is that we can’t grow the economy much more. Maybe I’m wrong but this seems to be the implication.
Kalecki himself had unsettling implications as basically on some level business didn’t want a Keynesian shot to demand as they’d lose the discipline of having a large, unemployed-desperate-reserve army.
Coherly I certainly support raising the wages of workers the question is how we do that? In my reading of Lambert he seemed to be saying the way to raise wages is to cut the profits of business.
I do support doing that as we’ve gone from one extreme in 1980-where profits were being squeezed-to today where we have the oppostie problem. However, if we basically accept a ceiling of growth at just about 2.2% GDP I think it will be harder to get acceptance for redstribution
sorry. i worked for that asinine fairy tale for quite a number of years.
that does not mean that i think workers in general slack off. what i was saying mostly is that some of them will slack off under a regime where everyone is guaranteed “equality.” and no, this does not make me right of center.
what i also said was that i despair of any of us ever saying anything anyone else understands.
I really think you have the implication wrong, but I’ll leave it to Lambert to explain himself, as I agree that he seems to leave himself open to the concern.
As to what “business” wants, I think most businessmen are just like you and me. They want to make money and they are willing to pay a fair wage. But there is a whole industry devoting to lying about economics…and some of the best liars get Nobel Prizes. And there are plenty of people who own businesses or would like to, who believe the lies. I think on a political level, the folks who make decisions probably do like a reserve army of the unemployed. They sure seem to panic whenever workers start doing better.
There’s two ways to understand business-as individual business owners and in that they are just like you and me. I don’t demonize them personally at all. Still, the trouble is ‘rational irrationality’ where sometimes what is rational and reasonable on the individual level is quite different at the social level.
The reserve army theory of Kalecki’s is a serious charge that has to be considered.
agree about business owners as individuals and as “class.”
i don’t know about Kalecki so am not likely to consider it unless someone makes a case for or against.
my guess is that any case that is worth making can be made without referring to a particular author or model.
what i mean by that is the real world presents problems that need to be solved in their own terms, and whenever an expert goes off into citing other experts or economic models it seems to me they get lost in their own heads and plain facts about what happens to real people get forgotten about.
Well though Kalcecki may have been the first to suggest it the idea of the reserve army is understandable enough. Actually he probably wasnt literally the first as Marx talked about the idea a lot. Kalcecki just suggested that because of the need for using a reservie army as a way to ‘discipline’ labor business owners-as a social class-may resist going too far with full employment policies that would take away this power to discipline-which enables them to keep wages down.
Today clearly the large number of unemployed-or underemployed-give them this power.
Coberly it looks to me that I may be wrong as you say. In readinng Lambert’s Ciruclar Flow for Labor model, what he actually is saying is that a drop in labor’s share of GDP actually lowers GDP whereas a rise in labor’s hare raises GDP.
He had actually written about this on the 6th but I hadn’t noticed that piece.
let me commend you for doing that. if more people checked their work we’d have less to fight about.
I just saw that all the above comments went to my spam box.
I must say, that Mark Sadowski made many errors in his analysis. Is anyone still around here?