Abstract
Henry George often argued in macroeconomic terms, though he did not develop a macroeconomic theory. In this chapter we present a model that is consistent with Marshall’s ‘supply and demand’, but applies to aggregate supply and demand. The model is based on a conventional short-period production function, which shows the outputs associated with various levels of both fixed plant and equipment employment. As the economy employs craft technology, returns diminish to additional employment. Then, wages support consumption, Kalecki-fashion investment generates realized profits, and the level of employment is found when we know the real wage and level of investment (at the point where the C + I line is tangent to the production function, so the real wage equals the marginal product). This system can be developed into a simple growth model, based on the “Golden Rule” that the rate of profit equals the rate of growth, replacing the misguided Solow model.
The Price Mechanism … stabilizes the economy.
—Almost Any Mainstream Economist
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Notes
- 1.
An unsettling possibility arises here, which is that investment might be undertaken not to improve the product or reduce the costs but for a firm or group of firms to impose costs on competitors. A mill owner might buy a farm upstream from his major competitor, and divert water from the stream for use in irrigation, reducing the force of the flow driving the competing mill. Regulators might stop this, although irrigation could surely be a legitimate use of water—but if it is not, regulators can sometimes be bribed. Very commonly, a firm will find some reason to sue its competitors, if it believes that the cost or inconvenience to them will be great enough to warrant the legal expenses—even though there is not much of a case against them (a practice widely attributed to Donald Trump). The targets of this kind of behavior may be asked, or may offer, to pay a fee to stop it—a rent! For an interesting survey of such “rent-seeking” behavior (which, if it absorbs investible resources, may thereby reduce growth), integrated into endogenous growth models, and starting from Adam Smith, see D’Agata, Ch 11 in Kurz and Salvadori, ed. (2003).
- 2.
Note that in actual fact these relationships will be rough and ready, discontinuous; we are smoothing them out and assuming continuity—so that we can draw diagrams recognizable to economists!
- 3.
To avoid complications, we will assume that when demand changes, it changes in the same percentage for all firms. In practice, the better firms might well use the opportunity of shifting demand to improve their competitive positions.
- 4.
- 5.
Wages and salaries in the aggregate are closely correlated with consumption spending but do not fully explain it. Some obvious adjustments are easily made. Consumer spending also depends on the terms and availability of consumer credit; in addition, it reflects transfer payments. Wealth and profitability are significant variables. But for the present purposes, which are purely illustrative, a simple “absolute income” theory will suffice. Prices here are assumed to be flexible both up and down, more flexible than money wages, which are also adjustable. Employment is inflexible; firms do not want to break up skilled work teams; output, however, is somewhat flexible, varying in different industries, depending on many factors. This is all spelled out fully, with supporting statistics, in Nell (1998a), Ch 3, under the heading “The Old Business Cycle.” See also Nell (1998b). For further support, see A. Marshall and M. Marshall, The Economics of Industry, London: Macmillan, 1879, Ch xiii, pp. 146–7, Book iii, Ch 1, pp. 150–3, see esp. sections 3–5, p. 165, sections 8, 9.
- 6.
Even though K∗ is temporarily fixed, dK∗ is acceptable here because Y is a function of two variables, and when N changes, the marginal product of K is affected because the ratio N/K∗ has changed, even though K has not.
- 7.
Note that in a craft economy—the Old Business Cycle—saving always tends to equal investment because investment spending, the active force, drives up prices (or, if itself slack, lets them sag), which changes profits, so that saving adjusts to investment.
- 8.
The similarity of this to the Solow growth model of textbook fame is unmistakable. But Solow added an assumption that is usually overlooked: although he introduces the marginal productivity relationships for both the real wage and quasi-rents, he assumes that prices will be constant (Solow 1956, p. 79). As a result there is no price mechanism in his model. There is no justification for Solow’s assumption of a constant given price level nor does he pretend to offer one—but it completely changes the character of the model. For, as we have seen, it is the price mechanism that ensures that the marginal productivity conditions are satisfied. Solow, on the other hand, assumes that savings will drive investment, though no mechanism is specified, and that the equilibrium growth rate will be determined by the changing capital/labor ratio, brought about by such saving. (Higher savings will drive interest rates down, and that will increase investment? Not a chance, empirically; not satisfactory theoretically, for Keynesian reasons.) The Solow model got mainstream growth theory off to a bad start and has stood in the way of progress for almost two generations.
- 9.
The “golden rule” of capital accumulation, that the rate of growth should equal the rate of profits, was much discussed in the 1950s and 1960s, following a challenge by Joan Robinson. Neoclassicals argued that it maximized consumption per capita (Phelps, 1961, 1965); neo-Ricardians thought it represented a balanced path. Nell, 1970 argued that when r = g, the value of capital would be constant when distribution changed. See Robinson (1956), Harcourt (1972), Nell (1970, 1998a).
- 10.
As the economy grows the banking system must grow pari passu, which means bank capital and bank reserves must be augmented along with other investment. The level of bank capital—the capital of the banking system—will support a certain level of bank loans, while the difference between deposit and lending rates will provide the profits of banks. The sustainable ratio of bank loans to bank capital can be indicated by λ; then λ(il − id) = rb, the profit rate of banks. When this profit is reinvested, bank capital, and therefore sustainable bank lending, will grow at this rate. If the profit rate in banking is the same as in the rest of the economy, and the rest of the economy likewise reinvests its profits and grows at the golden rule rate, then the credit money required will always be available.
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Nell, E. (2019). Savings and Investment, from the Price Mechanism to the Multiplier. In: Henry George and How Growth in Real Estate Contributes to Inequality and Financial Instability . Palgrave Studies on Henry George for the 21st Century. Palgrave Pivot, Cham. https://doi.org/10.1007/978-3-030-18663-0_5
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