A natural rate of unemployment in the Cobra equation
This post continues the exploration into the Cobra equation, which measures the profitability of utilizing labor and capital as a function of labor share. Now it looks as though the Cobra equation is implying a natural rate of unemployment.
The simplified Cobra equation is now…
Measure of profitability in the aggregate = (x + y) – ax2y2
y = employment rate
a = coefficient for labor share to establish profit maximization.
The Cobra equation is in 3 dimensions, but I have made a 2 dimensional graph of it with an Excel spreadsheet.
The equation for profit maximization (orange line) is simply the derivative of the profitability measure above with respect to x then solved for y, employment…
The blue line is the effective demand limit, which has the equation…
As the economy utilizes more labor and capital in the expansion phase of the business cycle, it eventually reaches one of the two lines and stops. Then the economy will either rise up the line employing more labor or it will contract into a recession.
It appears so far in the data that the economy gravitates to the crossing point of the orange and blue lines. The blue dots mark the crossing points as changes in labor share shift the lines. (Labor share is increasing from left to right.)
The blue dots imply a natural rate of unemployment, because the economy gravitates to there in equilibrium. The natural rate of unemployment implied in the graph stabilizes at higher rates of labor share (to the right). Then as labor share falls to 70%, the equilibrium crossing point drops implying a higher natural rate of unemployment. Then as labor share falls below 70%, the equilibrium point reverses direction and starts rising implying a lower natural rate of unemployment.
The unemployment limit is tied to maximizing profit, right? While maximizing profit is optimum for business, I doubt it is very good for the unemployed. Perhaps business should consider hiring more people and making less profit.
Jerry,
This equation says that hiring more people is profitable, but that it leads to a contraction in capital utilization.
If business decides to employ more capital than people, they will run into the effective demand limit faster.
It is more profitable to employ people.
For almost two years business has stopped employing more capital. Now they are slowly employing more people.
Maybe I am being simple minded here, but if it is more profitable to hire people why does it matter if capital utilization declines. And doesn’t hiring more people raise the effective demand limit?
” But in fact, it is capitalistic accumulation itself that constantly produces, and produces in the direct ratio of its own energy and extent, a relativity redundant population of labourers, i.e., a population of greater extent than suffices for the average needs of the self-expansion of capital, and therefore a surplus population. …
….
But if a surplus labouring population is a necessary product of accumulation or of the development of wealth on a capitalist basis, this surplus population becomes, conversely, the lever of capitalistic accumulation, nay, a condition of existence of the capitalist mode of production. It forms a disposable industrial reserve army, that belongs to capital quite as absolutely as if the latter had bred it at its own cost. Independently of the limits of the actual increase of population, it creates, for the changing needs of the self-expansion of capital, a mass of human material always ready for exploitation. …
Progressive Production of a Relative surplus population or Industrial Reserve Army
http://marxists.org/archive/marx/works/1867-c1/ch25.htm#S3
MArx explained ‘natural unemployment’ as a function of capital accumulation. — the teo clips fail to give justice to he argument.
This may be better —
Progressive Production of a Relative surplus population or Industrial Reserve Army
http://marxists.org/archive/marx/works/1867-c1/ch25.htm#S3
Jerry,
You have hit the nail on the head. It does not matter if capital utilization declines, and it probably will. It is a process of reaching for profits.
And hiring more people actually lowers the effective demand limit in relation to real GDP. Effective demand is really a limit upon the utilization of labor and capital, so as you hire more people, holding capital utilization constant, the economy gets closer to that limit.
Capital utilization may decline as unemployment comes down over the next year. This would delay the economy hitting the effective demand limit. But it is tricky. Business would be following a profit incentive, but the decline in capital MAY or MAY NOT trigger a fall in confidence and thus a recession.
Juan,
You are bringing out the big guns… From my point of view, economic growth from a developing economy to an advanced and mature economy is decided upon whether effective labor share gets beyond the 70% hump or not.
China’s future as a world economic leader rests on this point. Otherwise, China’s power will simply bring down the rest of the world to its sub-optimal level.
We should all be pushing for higher labor share in China.
It’s surprising to find on angrybearblog.com a resource so precious about equations.
We will note your page as a benchmark for Angry Bear
Welcome to Angry Bear. We will let Edward know.