Capitalism is not about wealth, it is about capital and its continuous productive employment. Increasing inequality combined with rising wealth in non productive assets is essentially anathema to a structurally sound capitalist framework.
A big part of the problem is that key elements of the operational economic model, that which determines revenues and that which determine costs, have become disassociated from each other – marginal costs and marginal revenues need to be related. Additionally the model itself is also suffering from leakage as less profit is reinvested and earnings are increasingly distributed to those who will accumulate and not eventually consume, with consequences for asset prices, which themselves have a feedback loop into the economic engine.
I was reading a couple of posts on FT’s Alphaville (Robots won’t make you rich for long & The UK’s squeezed bottom, charted) and a Stiglitz piece on Project Syndicate (Stagnation by Design). The second Alphaville post provided a link to an important document on income disparity, produced by the Resolution foundation.
I disagreed with the gist of the Robots won’t make you richer (a repost to Martin Wolfe’s Enslave the robots and free the poor), largely because the post confuses the price of an asset in the stock market (GM stock) with the value of the actual capital invested to produce the goods and earn the profits, but I felt that there was a thread between the subject matter of these different views that was worth expanding on.
Fundamentally the economic growth engine is, on the one hand, an expenditure engine dependent on an optimal distribution of the returns (revenue) of production and on the other hand a reinvestment of excess return (profits) on capital, or indeed labour (savings from earnings).
This reinvestment drives the expansion of the future supply of production engine, itself a component of current expenditure. It is also a prerequisite for continued growth in the demand for labour, especially in the face technological progress and innovation. So profit in of itself is not a problem, and neither are large profits as long as they are recycled into productive capital investment.
But for the system to operate efficiently, revenue and costs need to be in one circular flow. If marginal revenue and marginal cost determine output, profits and wages then separating the cost source from the revenue source may well cause problems. Having labour in a foreign country produce the goods while consumers in the domestic market consume those goods can separate the sources, unless of course those foreign workers can themselves consume goods and services produced by the domestic market.
Optimal distribution of income is key to ensuring that consumers have sufficient income to expend and owners of capital sufficient return to justify the risk of investment and to reinvest. Reinvestment is key to maintaining a short and long term balance between demand and supply. It is when capital is taken out of the productive loop that ownership (wealth) and distribution (income) become problematic.
Working out the balance of the distribution is indeed difficult, but what is key to the effectiveness of the overall balance is the continuous reinvestment of the excess and the relationship between sources of costs and sources of revenue. Owners of capital need to take productive capital investment risks, otherwise capital, instead of being recycled into production, is likely to be recycled into non productive assets or assets representing ownership in productive capital (but which purchase of mostly involves a transfer of ownership and not investment per se). These non productive assets, or investments with no productive capital impact, tend not to create jobs or growth in the supply of goods and services.
Asset price bubbles are essentially an indication of cracks in the capital model, with distribution of income and profits being overly allocated towards assets instead of consumption and production.
In a virtuous growth model, profits on capital invested and savings from earnings are reinvested in new productive capital. Technological change reduces the cost of production and/or increases the productivity of labour in one area, releasing capital for expansion or investment in others. Employment may be cut in one industry, but will be increased in another. Cost efficiencies and productivity improvements should not necessarily lead to lower incomes and higher unemployment. In this sense Robots should release capital for investment elsewhere, creating new demand for labour, increasing real output and wages. The problem starts when capital is not reallocated, jobs are lost and demand falls. If capital cannot be productive it will ultimately cease to have value – land and tangible real assets (gold, property, art etc) become attractive.
In a virtuous growth cycle technological innovation does not lead to lower wages and higher unemployment but higher real output and rising returns on both labour and capital. In other words it expands the production opportunity set providing both demand for capital and labour and returns on both.
If excess returns are not reinvested in productive assets, but instead are reinvested (and disproportionately so) in non productive assets (new houses, country estates) or used to bid up the prices of securities representing the existing capital stock, capital is taken out of the system of consumption and production, impacting the growth rate of future production, the demand for labour, the growth in national income and hence impacting the marginal revenue that frames the marginal cost.
Worse, a technological advancement that does not lead to a release of capital for investment in other projects, but reallocates that capital to non productive assets takes out of the system both current and future demand. It also weakens the mechanism by which the returns on increased productivity are shared between labour and capital. Total wages may fall, total employment may drop, as will output,the stock of capital and the returns on capital.
It does not make sense, in a rationale world, for capital to continue to bid up the price of either non productive investment or holdings in existing capital investment if the returns on direct capital investment are sufficiently high. But it may make sense not to reinvest in new production or new technology if there is uncertainty over demand. Unfortunately, since the pricing of all assets is determined by the real growth rate of the economy, excess capital allocation to non productive assets not only reduces long term growth rates but will ultimately impact the price of all assets.
If a producer of goods moves production of goods offshore while the consumers remain onshore and the difference between the cost of goods production is shifted to owners of capital, then we may have a problem. We have a deficit in demand from those who once produced the goods and we have doubts over the viability of the reinvestment of profits to increase production when demand for these goods is uncertain. Only if the offshoring of production leads to a more efficient allocation of resources in the domestic market place, that it is reallocate labour to higher earning jobs in more technologically advanced industries can this work. Offshoring in this context increases the productivity of all workers, helps increase total output and wages and total consumption. Offshoring is a bit like a technological innovation in this context.
The income disparity argument is key to understanding some of the structural risks to economic growth. It increases the risk of misallocation of capital to non productive “investment” assets thereby creating asset pricing bubbles at the same time as weakening the productive growth platform.
I personally feel that we should indeed fear robots where there is:
A growing income disparity – where labour returns from production, and critically their share of productivity growth, are falling in a majority of cases and increasing disproportionately in a smaller number of cases and where returns on capital are increasing relative to labour. The consumption opportunities of the majority are being constrained while the consumption opportunities of the minority are insufficient to make up the differential in demand.
Where high consumer debt levels in key economies have accumulated for a number of complex reasons and represent a barrier to growth in personal consumption in an environment of low wage growth and high unemployment. Debt has increased because of a) asset focussed money supply growth that had helped elevate the cost of housing in particular, b) equity withdrawals from housing that helped fuel consumption, c) lower interest rates and lax regulation of lending, and d) the availability of easy credit and loans that allowed consumers to expand their consumption beyond the ability of future of earnings to finance. Again this is a complex area with numerous interactions.
Where there is high unemployment due to a prior shock and weak growth in demand for goods and services relative to historical benchmarks. The complex scenario that existed prior to 2007 combined an asset price bubble with elevated levels of consumer debt, which when confronted with a rising interest rate scenario caused a sharp correction in expenditure and asset prices that also came back through the financial system. Consumer expenditure was above levels the economy could support over the long term, and it still is given that in many countries final demand has been supported by increased government expenditure and hence government debt.
Where output, in certain economies, is below the capacity for a given pool of labour, capital and technology – existing capital is allowed to depreciate at the margin, excess returns are not fully reinvested in future production capacity, labour and capital are in excess supply. These economies need revenue at a certain level to support current capacity and to finance large debt levels, yet the imperative is on cost reduction and containment, neither of which are pro growth.
Where there are existing significant global structural imbalances between consumption and production: in some economies there is over investment and production and insufficient consumption, while in others there is insufficient production and investment. If we could get consumption in certain economies higher, preferably consuming more goods and services from those economies where there is excess consumption and insufficient investment in future production, the imbalances that are influencing income inequality would narrow. Low wage cost emerging and developing economies have put labour costs in developed economies under intense competitive pressure. Unfortunately the larger markets for these products are the same markets in which labour costs are under pressure and in which there is a large pool of unemployed labour.
A short term profit obsesses focussed culture that appears comfortable with rewarding executive for short term share price performance to the detriment of the capital model.
The world has effectively been using some form of robot for time immemorial. Anything which frees up capital and allows a worker to produce more is some form of automation. With a robot however, we remove the need for any form of labour in the actual production process itself, which takes labour out of the distribution of productivity equation. The only way technology improves standards of living is if new vistas of demand for labour open up and the returns of production loop back sufficiently into current demand and future demand. Capitalism is not about wealth it is about capital and its continuous productive employment, and increasing inequality combined with rising wealth in non productive assets is essentially anathema to a structurally sound capitalist framework.