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Dual nature of investment: it generates capacity, it generates aggregate demand

Lecture notes on accumulation theories The mather (or father) of all growth models: Harrod’s model and the instability problem. Dual nature of investment: it generates capacity, it generates aggregate demand. The model:. S 1 = sY 1 (1) (multiplier)

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Dual nature of investment: it generates capacity, it generates aggregate demand

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  1. Lecture notes on accumulation theoriesThe mather (or father) of all growth models: Harrod’s model and the instability problem • Dual nature of investment: it generates capacity, it generates aggregate demand

  2. The model: S1 = sY1 (1) (multiplier) I1 = vn (Y1E - Y0) (2) (accelerator) S1 = I1 (3) (equilibrium in the commodity market: there is dynamic equilibrium if I1 generates a growth of AD and capacity such as to generate an identical S1) vn = K/Y = DK/DY is the desired (or required) capital coefficient, s marginal propensity to save "The axiomatic basis of the theory which I propose to develop consists of three propositions, namely: (a) that the level of a community income is the most important determinant of its supply of saving; (b) that the rate of increase of its income is an important determinant of its demand for saving; and (c) that demand is equal to supply. It thus consists in a marriage of the 'acceleration principle' and the 'multiplier' theory" (Harrod, 1939, p.43). 16/08/2014 2

  3. The warranted rate and the instability question • Gw = s/vn, is the so-called warranted growth rate . "The warranted rate of growth is taken to be that rate of growth which, if it occurs, will leave all parties satisfied that they have produced neither more nor less than the right amount" (1939, p.45). • GE = s/vn , that is if the entrepreneurs expect a growth rate GE = Gw = s/vn, then the economy grows with a goods market equilibrium (GA = GE) • If the entrepreneurs knew Gw, they would decide an investment level that would precisely generate Gw. But they do not know it. • Instability: • If GE > GW GA > GE and next time they will expect an even larger GE • If GE < GW GA < GE and next time they will expect an even lower GE

  4. Harrod = Say’s Law? • We might, however, reverse the argument and say also that if the entrepreneurs invested all capacity-savings, that is if I1 = S1 ( they believe in Say’s Law), then the economy would proceed at Gw. • that is if capitalist behave according to Say’s Law, they would grow at Gw. Harrod as a dynamic version of Say’s Law.

  5. Problems with Harrod • That is, if entrepreneurs believed in Say’s Law and invested all savings, the economy would grow at Gw (which would also be the actual growth rate GA). • But neither they know Gw, nor they behave following Say’s Law. As we shall see, Kalecki commented: capitalists do many things as a class, but they do not invest as a class. • In other words, they refuse a collective planning of their investment (indeed Harrod was influential on quasi-socialist government planning of investment after WW2). • Harrod’s model raised two questions: • Gw is not a full employment path: this is a problem only for neoclassical economists • Gw is unstable, that is the economy does not gravitate around it (not surprisingly, unless you believe in Say’s Law, there is no reason why in Harrod S = I).

  6. Instability seen through the lenses of the degree of capacity utilisationNormal degree of capacity utilisation : the average degree of capacity utilisation desired by the entrepreneurs un= Yn/Yf where Yf is the maximum physical output from a given capacity K. In general Yn < Yf and un < umax. The main reason (Steindl) is that firms want to keep a margin of non utilised capacity to meet sudden peaks of demand; if peaks persist, they will increase capacity. When GA > Gw, it means that s/va> s/vn,, that is va = K/Ya < vn = K/Yn Ya > Yn or, in terms of degree of capacity utilisation u, ua = Ya/Yf > un = Yn/Yf Ya > Yn Read in the opposite direction: whenever GA > Gw, Ya > Yn ua >un, the actual degree of capacity utilisation ua is higher than normal (so entrepreneurs invest even more to restore un , but in this way they perpetuate the disequilibrium. The opposite would of course happen when GA < Gw (ua < un and investment would keep falling to absorb the less-than-normal u).

  7. Anticipation • To anticipate what will follow when we shall consider the heterodox growth models, one way to accommodate Harrod’s instability is to say: if GA > Gw and both va < vn and ua > un , then we take va and ua as the “new normal” capital coefficient and degree of capacity utilisation. But this sounds a post hoc ergo propter hoc kind of reasoning however adopted by the influential ‘neo-Kaleckian’ growth models. * an expression now in vogue to indicate a perennial state of crisis of capitalism

  8. Two roads to get out from Harrod’s troubles • Harrod influential in the 1950s (the market economy is unstable, then the State must plan the economy: France’s planning, in Italy Piano Vanoni, India’s planning). This is normative, but Harrod is unsatisfactory as a positive explanation, markets are unstable, but not explosive. • Note a “traditional” feature of Harrod’s model: s positively influences Gw and growth is endogenous (in the sense that it depends on preferences about present an future consumption). Perfect for a neoclassical economist, were not for the absence of full employment. Solow’s neoclassical growth model (1956) recovers full employment, but losses, somewhat paradoxically, the influence of s on G. Endogenous growth theory (that actually begun in the early 1960s) is just on having both. • Two early ways out form Harrod’s problems: Solow’s neoclassical growth model and the Cambridge Equation (later followed by other heterodox schools)

  9. Two roads to get out from Harrod’s troubles II • Main characteristic of the neoclassical approach is the dependence of investment from savings, more specifically from full-capacity savings, savings that spring from a productive capacity that both is fully (or normally) employed, and also fully employs all the labour supply. • Main characteristic of (most of ) the alternative approaches is what Garegnani named (after Kaldor)the “Keynesian Hypothesis” (KH) that investment are independent from savings both in the short and in the long run.* • This is the striking difference between neoclassical economists of all persuasions (including neo-Keynesians a là Blanchard, Stiglitz, Krugman, De Long etc): aggregate demand determines output both in the short and in the long period, or more precisely, it is capacity that adjusts to aggregate demand both in the short and in the long period. We shall begin from neoclassical growth story. • * There are a number of “heterodox models” that are “keynesian” in the short-run and “Classical” (in the sense of Say’s Law) in the long-run (e.g. Shaikh, Foley and Michl; Dumenille and Levy; Kurz and Salvadori?). We shall not study them.

  10. After Harrod

  11. Just a word about Endogenous Growth Theory • Let us note first that the capital theory critique precisely concern the neoclassical substitution mechanism. So in general we may say that Solow’s model does not show any convergence towards a full employment path. • Many empirical studies show that there is a positive correlation between I/Y and G. Through neoclassical lenses (I = S) this is a correlation between s = S/Y and g. But this does not come out from Solow! (in Solow a rise of s only affect y not G). • From the very early sixties this is the start of EGT: a desperate attempt to establish a connection between s and G. • Not surprisingly, most of EGT is a return to Harrod (G is endogenous in Harrod) • If curious, please see my WP on EGT (and the one with Serrano)

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