Anwar Shaikh’s Classical theory of inflation

9780199390632Economic theory needs to account for the phenomenon of inflation. This post draws on Chapter 15 in Professor Anwar Shaikh’s recently published book Capitalism in which he outlines his theory of inflation under modern fiat money (state-backed money not fixed in value to gold or another commodity). He contrasts it with neoclassical and Keynesian theories, and provides empirical evidence to support his ideas.

The essence of Shaikh’s model is quite simple. Inflation, a rise in the overall price level in an economy, is determined by aggregate demand and supply, and these are influenced by three factors having either a positive or a negative effect on it: new purchasing power (PP), net profitability (the rate of profit minus the interest rate, rr) and the so-called ‘growth utilization rate’ (u).

PP is a demand-side factor, and the other two factors operate on the supply-side. PP is influenced by private and public sector credit, or a rise in borrowing to fuel greater spending in an economy. Note that this can be generated domestically or from abroad, for example through a rise in net exports. In theory, under modern fiat money, the amount of PP generated by the government ‘printing money’ has no limit, and history shows that in wartime, governments have often financed the extra demands on their activities through the creation of new money, which has given rise to inflation. This source of inflation, generated from the demand-side, seems similar to monetarist theory, in which the state is to blame via its intervention in the economy and its creation of an excessive growth of the money supply, and trying to keep unemployment below its ‘natural rate’. Continue reading

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Workers’ rights and the European Union

workersA nice piece by Labour MP Hilary Benn, son of the late Tony Benn, on why ordinary workers, men and women, part-timers and full-timers alike, benefit from EU membership. Many Tories see labour market regulation as ‘red tape’ and a burden, and would happily sweep away workers’ rights and protections.

The claim is sometimes made that such regulation destroys jobs, but the UK already has one of the least regulated economies in the advanced world, whether one looks at labour or product markets. Despite that our productivity level remains relatively poor when compared with a number of EU member states, with little sign that we are catching up. Employment levels may be high and unemployment reasonably low, but in the longer term, it is productivity which determines living standards. Continue reading

‘Decent work’ as a development goal

DSC00236aAre decent working conditions a luxury only achievable in rich economies? In other words, are their improvement part of economic and social development? Or could they underpin efficiency alongside social justice even in poor countries? In a paper published in the book Systems of Production (Burchell et al 2003), Gerry Rodgers considers these issues.

Rodgers answers the above by suggesting that improving working conditions are or should be part of the development process. Some basic rights should be achievable anywhere, but they should also be able to adjust upwards as an economy becomes richer, or when economic resources allow.

He defines decent work as the availability of employment, certain rights at work, a degree of security and workplace representation which promotes constructive dialogue between management and workers. Continue reading

Market failure on a grand scale: housing and productivity in the UK

Northwest_Kowloon_reclamation_area_no._6_public_housing_estate_construction_siteProductivity growth in the economy makes advances in living standards possible. As output per hour increases workers can, at least in theory, make some sort of choice between an increase in wages and an increase in leisure time. They could either produce and earn more for constant hours of work, or possibly earn the same for reduced working time and increased leisure.

Rising productivity also potentially allows profits to rise, which can be reinvested in production, or used to pay dividends or interest and repay loans used to finance investment.

Of course, the workings of the market economy and the way rising productivity is distributed between wages, profits and other forms of income are more complex than this stylized description. The balance of power between different groups in society has an effect on the distribution and appropriation of wealth and income. Continue reading

A sustainable labour market: what kind of structure?

A sustainable labour market structure, at industry-wide and national levels, should enable the productive efficiency of the economy to grow over time, and promote at the same time high levels of employment and low levels of unemployment. In a modern democracy, mass unemployment is unsustainable because it represents a tremendous level of waste, and also because it is likely to create social unrest and can undermine the very foundations of such a democracy. Governments may not always be able to ‘control’ the economy such that mass unemployment is banished for ever, as the current economic crisis has made clear, but they can pursue policies which banish it for considerable periods of time, and should do so.

Measures of economic growth record the increase in the production of goods and services in an economy over time. But growth is a complex process and involves a change in the structure of production over time as well. Companies and industries fail and can disappear altogether while new ones start up and develop. Jobs likewise ‘disappear’ both within such companies and industries, as well as within growing companies. New jobs are at the same time created across the economy. The balance between the two over time determines whether employment levels rise or fall.

As Geoff Harcourt has argued, in theory a ‘rigid’ labour market with industry-wide wage setting behaviour by trade unions is not incompatible with a dynamic economy. If wages are set at some uniform rate across an industry, those (less successful) firms with inferior techniques and low and declining profits will be forced out of business quicker without being able to cut their workers’ wages, while those more successful firms with superior techniques of production and higher profits will be able to sustain and expand investment and output without being hindered by flexible wage-setting behaviour forcing wages higher. Inferior techniques will be scrapped more quickly and resources will be re-allocated towards superior techniques of production. Economic growth and structural change can in this theory proceed apace.

I have been wondering about the more orthodox view that regards flexible wages across the economy as important facilitators of structural change and growth. In this theory, less successful and failing firms will be forced and able to cut wages to maintain profit levels, while more successful and profitable firms will be able to raise wages. In fact, they will want to raise wages to attract more labour as they invest and expand output. Workers are likely to respond to the different wage levels as a market signal, and apply for jobs at the firm which offers higher wages. Competition will prevent the failing firms from cutting wages too far, for fear that they will lose their workforce to rival firms, or even firms in a different and more successful industry. In a way similar to the ‘rigid’ wage-setting behaviour outlined in the paragraph above, the dispersion of wage levels across an industry and even the whole economy will have limits set in this case however by the forces of competition in the labour market as well as the market for firms’ output. In the first case, wage-setting is more institutionalised by trade unions, in the second it is market-driven. But the outcome of both cases does not seem too dissimilar in theory.

In theoretical terms then, institutionalised wage-setting in a market economy need not imply a stagnation of output caused by inhibited structural change. It is highly simplistic to argue that trade unions by themselves and in all cases cause unemployment and slow economic growth. Cross-country case studies would seem to suggest this. The Scandinavian economies have in general been successful in recent years, while maintaining strong welfare states and, I believe, trade union movements of significance. The large economies of France, Germany and Italy have to varying degrees suffered from high unemployment for decades now, and many economists have come to accept that labour and product market ‘rigidities’ have been the cause of this. Personally I would add restrictive monetary and fiscal policies maintained over long periods, and the costs, both static and dynamic, of German reunification. Economists need to take a subtle approach to recommending structural ‘reform’ to these governments. And these governments need to be bolder, in the face of economic crisis, with their macroeconomic policies, to prevent unemployment rising more than it needs to in the medium and longer term.

A sustainable labour market structure then, can be compatible with the presence of trade unions, especially those that accept that structural change is part of the dynamic of economic growth and development. Other ‘rigidities’ may or may not be compatible with this dynamic and labour market regulations and structures require close study before recommendations are made for blanket reforms which could sweep away those institutions that sustain social cohesion and also promote the very dynamism that economies need to grow.