Attractor States in the Business Cycle… Sluggishness is due to low Labor Share not low Productive Capacity
This post has been updated!
I just posted about the Silly Confusion over Potential GDP. The main idea of the post is that real GDP made a transition to a new normal level after the crisis. And patterns from past business cycles show that real GDP stays close to this new level. But then two commentators (Axt113 & Mike Meyer) put forth this idea…
“Are you arguing that had we invested in infrastructure to the amount the ASCE had called for, the economy would not be churning along at a much higher level by now?
Seems to me like the lack of such investment was a huge policy mistake that was a detriment to our economic growth.”
In essence, they are saying that we could have escaped that new normal through infrastructure spending. A lot of economists are saying that. Here is my shortened and revised response…
“Real GDP made a smooth transition to a normal level. And once it settled into that level, the business cycle proceeded as normal employing labor and capital along the blue line. That has been the pattern for all business cycles before. The normal pattern is that once the business cycle settles into its level, it tends to stay close to that level.”
I am describing the attractor state of Real GDP. (link about attractor states) The blue line in this graph shows the attractor state…
“I want to call the blue line in the graph above an attractor state for the business cycle. I am not sure that is the best term, but let me go with it here.
You are saying that we could have shifted the real GDP line up above its “attractor state” blue line by infrastructure spending. I am making a case against that view…
According to past patterns, all we would have done is move up the attractor state blue line faster. Real GDP has moved up the blue line faster in the past. We would have employed labor and capital faster along the attractor state line. However, that blue line would not have shifted up. The past patterns show us that the blue line only shifts up at the very end of the business cycle as effective demand puts a profit rate limit on the utilization of labor and capital.
So Yes, real GDP would have risen faster, but we would have hit the effective demand limit faster too. Thus you would have shortened the business cycle.
Now, if increased infrastructure spending would have somehow increased labor’s share, then you would have extended the business cycle as you shortened it. The result would be a less shortened cycle.
However, past patterns show that effective demand also settles into an attractor state. It rarely shifts up during a business cycle.
So in all, I think your idea would have just shortened the business cycle.
Let’s realize that everyone acknowledges that we need to know more about how the business cycle works. And what I present is not found in any books. It is my own personal work. Yet, it shows patterns that repeat.
This next section was updated with corrected numbers…
One thing to add… Currently real GDP is trending toward $21.750 trillion (2009 real $$) at 100% utilization of labor and capital (the limit of the x-axis for the blue line in the graph above). We have been employing labor and capital directly toward that constant level of productive capacity. Other business cycles moved toward lower yet also constant levels. Let me call it an “attractor” productive capacity.
The previous cycle before the crisis had an attractor productive capacity of $18.6 trillion (2009 real $$). The business cycle before the 2001 recession ended up with a productive capacity of $15.8 trillion. So there was a 18% jump in attractor productive capacity between those two business cycles.
The attractor productive capacity before the 1991 recession was $10.6 trillion. After that recession, the economy settled into an attractor productive capacity of $12.5 trillion, an 18% jump. Then the attractor productive capacity rose 26% to a new level during the dot.com bubble.
The current jump from $18.6 to $21.7 trillion is a 17% jump.
That is the largest jump since the 1980’s. That is a normal jump for historical data.
So doesn’t it seem to you that the current jump in productive capacity is normal? Well it is…
Productive capacity is not the problem with the economy. Economists continue to think that increasing production with monetary and fiscal stimulus is the answer.
No… the problem is demand… more specifically low effective demand from low labor share. The economy will seem sluggish and under-performing in terms of the utilization of labor and capital. For example, housing is slowing down because the rich are slowing down their purchases, and the middle and lower incomes are not strong enough. The key is to raise labor share.
Yet, labor share is in its own attractor state and will not budge until another recession can allow it to shift. Hopefully it will not shift down. So we will have to make sure it shifts up when that time comes.”
In brief, real GDP is on an acceptable level in terms of productive capacity. Yet, the economy is sluggish in terms of utilizing labor and capital because labor share has fallen so much. Monetary and fiscal policies are limited in their ability to solve this sluggishness. The solution is to institute policies to raise labor share.