Labor Productivity: Fear of social instability and the dream of economic growth

By: Shahab Sabahi, Energy and Environment for Development – Research Group

The conventional macroeconomic model implies when demand for goods and services falls, revenues to firms are reduced, leading to job losses and reduced investment. Reduced investment leads to a lower capital stock which, together with a lower labor input, in turn reduces the productive capability of an economy. Public revenues also fall, debt increases and the economic system has a tendency to become unstable. This logic supports the fundamental idea of rising and continuing consumption growth for long term economic stability.  

The model argues that a lasting consumption growth is feasible. It provides a formulation the key relationship between supply and demand. In a simple way, it says, income is calculated as labor input multiplies by the productivity of labor. In this simple formulation the dependency on capital, technological progress, efficiency and resources is all rolled into the factor of labor productivity. Thus labor productivity can be thought of as the average amount of income generated by an hour of labor input. In effect, if the labor input remains constant then growth is determined merely by the increase in the labor productivity. In capitalism, labor productivity is expected to grow over time, as technologies advance. It benefits the supply-side by increasing output and eliminating the need for additional expensive labor input. Furthermore, this increase in income, the model advocator believes, promises society-wide prosperity.  Though in the real world, the evidence tells different story

If labor productivity grows in a larger pace than labor input growth rate (e.g. aging population or purposefully reducing the share of expensive labor input in production), the only way to stabiles economic output, in long term, is by reducing further the labor input that means accepting some underemployment. Not only unemployment leads to low consumption demand which in return undermines the economic system, but it destabilizes the society.  

By persisting only in the idea of improving labor productivity and continuing consumption growth, we just try to mend the economy. Particularly it is the case for developed countries. Mending economy may work for a while but soon or later it will stall. There is no doubt that continuing labor productivity improvement is essential. But the question is about its pace. Its growth rate should be in harmony with labor input growth rate. It is not easy sailing, but few strategies have been adopted by governments; such as work-time sharing which, look promising toward a long term social stability. We should discuss more about this subject before getting fooled by another version of this complex macroeconomic model.

Friendships – My Christmas Gift

By Shahab Sabahi, Energy and Environment for Development – Research Group

You may remember that once asked me; how to communicate with people and make friendship? My partner says. My partner continues “People buy ready-made things in the shops. But since there are no shops where you can buy friends, men no longer have any friends. If you want a friend, tame yourself!” What should I do? I asked.

“You must be very patient. First you will down at a little distance from one who wish to make friendship. One shall watch you out of the corner of one’s eye and you will say nothing. Words are a source of misunderstandings. But every day you can sit a little closer to one. You should come back at same time every day. One shall start feeling happy at an hour before the meeting time. As the time passes, one shall feel happier and happier. At the meeting time one shall become agitated and start worrying. One shall discover the price of happiness. But if you come just at any time, one shall never know when should prepare one’s heart to greet you. One must observe certain rites.”

“Now my partner; do you see the ocean? I do nothing to do with it. The ocean does not remind me of anything. And I find it rather boring. But you have heart the size of the ocean. So it will be marvelous when you tame your mind with the influence of your heart. The ocean, then, will remind me of you and I shall love the sound of the wave in the ocean”

Inspire by my partner and courtesy of Antoine De Saint-Exupery’s book “The little Prince”

Nationalism, nation’s economic life

By Shahab Sabahi – Energy and Environment for Development – Research Group

The twenty centuries was marked by the progressive process of the fusion of the nation’s fate with the fate of its globalized economic life; but the tendency of this century amid climate change and resource security is the growing contradiction between the nation and globalized economic life. In developed countries this contradiction has become intolerably acute.

The social tensions in national and regional level, like all the upheavals of history, stirred up various historical questions and in passing give the impulse to national-wide radical changes in the more economically stagnated nations. But these are only the belated echoes of an epoch that had already passed away. With emotional methods societies attempt to solve a problem of progressive historic development, the problem of organizing economic life over the entire arena which had been prepared by the uneven distribution of wealth and power.
Needless to say, the social unrest and regional conflict have not and will not find any solution to this uneven distribution problem. On the contrary, it atomizes the world regions even more. It deepens the interdependence of the developing regions to the developed ones at the same time that it deepens the antagonism between them. It gave the impetus to the independent development of the developing regions and simultaneously sharpened the dependence of the developed regions upon the developing regions’ markets. As the consequence of the ongoing upheavals, all the contradictions of the past are again aggravated.  Developing countries have improved their economies from top to bottom. They might effectively organize productive forces but inevitably it implies the reinvigorating of all those evils that had led to the social unrests in developing countries in the past.

The present crisis, which is synthesized all the capitalist crises of the past, signifies above all the crisis of national economic life in the global sphere. International organizations attempt to ease this contradiction by translating from the language of militarism into the language of diplomatic pacts the task which the war left unsolved in the twenty century. But the perpetual series of political, economic, financial, tariff, and monetary deregulations only unfolded the panorama of the bankruptcy of the prevailing global governance structure for deal with this contradictory.

How may the economic unity of the world be guaranteed, while preserving complete freedom of individual and cultural development to the peoples living there, in the context of scares resources? If an answer to this question may exist, it certainly is not by military and diplomatic methods. Toiling and thinking humanity proves incapable of grasping in time of pride of itself, when emotion blinds its eyes to recognize how to organize productive forces correctly on a community scale.

Negative forces of ultra-competition and victorious bankers

By Shahab Sabahi – Energy and Environment for Development – Research Group

The sociology of development literature identifies four phases in the development of the capitalist world system; the mercantile phase in the 16s and 19s, it was the transfer of an economic surplus through looting and plunder, disguised as trade. The characteristic commodities of this period were gold, sugar, spices and slaves. The characteristic institutions were slave plantations and the plunder of central and South American societies. Between 1800 to1950, the colonial period, that witnessed the transfer of an economic surplus from peripheral regions to the center through ‘unequal terms of trade’, by virtue of a colonially-imposed international division of labor. In this harsh perspective, the developed center provided the under-developed periphery with simple manufactures, which were exchanged for food and raw materials, but the colonies had to provide increasing volumes of primary exports to by the same quantity of manufactured imports. The characteristic institutions were east European wheat fields, Brazilian coffee plantations, Argentine beef ranches and Lancashire cottons. The neo-colonial period took place between 1950 to1970 when the transfer of an economic surplus from the periphery to the center through ‘technological rents’. It means that when former colonies were given political independence, they were ‘encouraged’ to retain economic links with their former occupying power, and in some respects these economic linkages were strengthened through aid and assistance packages. The latter occur when first world companies establish plant in third world countries, to utilize their advanced technologies and cheap, unskilled labor, thereby making high profits. The characteristic institutions were ‘tied aid’ and ‘foreign direct investment’ (FDI). The main ideological terrain ranges over modernization theory and dependency theory. The modernized trend is so-called: post-imperialism has set out since 1970 onwards It witnesses the transfer of an economic surplus from the periphery to the center by debt repayments. The characteristic institutions were syndicated sovereign lending and are debt rescheduling packages, with ‘IMF loans’. The main ideological terrain concerns the differing interpretations of globalization.

What about now, the age of free trade and globalization? How does the international socio-economic work? Who are dominant powers? How do dominant powers control the socio-economic system?

The debate has been hot for and against the Marx’s perspective on political economy. Marx believed that ultra-competitive nature of capitalism would tend to depress the levels of profit in the capitalist system. Industrial companies would tend to become dominated by the banks and other financial institutions, which in turn would pour money into the development of new markets and new sources of production overseas, where materials were more abundant, labor cheaper, and demand for basic products potentially infinite. As dependency theory concerns, there are those who have followed Marx to argue that the capitalist powers did more damage in the structure of economy through their dominance of politics and institutions, leaving the structure and ideas that had much more to do with the needs of the powerful banks than with other elements of the . Perhaps one can expect, after the age of classic imperialism (annexation of colonies) and direct rule which turned to be costly, the emergence of powerful banks and financial institutes (in the shape of free trade and capital flow), which is cheaper, and involved domination by unequal exchange.

In short, it sounds, nowadays, that the powerful institutes (e.g. banks) use their control of trade and finance to gain excess from free trade even by manipulating political systems. It may be thought, as some suggests, much more of a political than an economic phenomenon; essentially a political response to disturbances. But I am not convinced by this sort of arguments and sill I believe that this stems from the nature of competition.  

The root of short-termism: implication for institutions

By Shahab Sabahi – Energy and Environment for Development – Research Group

If public policy experts are asked to describe the global challenges, they will provide a rich account of most important problems, potential solutions, and typically the institutional constraints to the solutions. What is institution? How do the experts assume the role of institutions in their analysis? In a broad sense, institutions are rules of the social game in which individuals interact with each other and the society as a whole. This definition links institutions closely with the way individuals think. Rules reflect cause-and-effect relationship. But causality is also fundamental organizing principle of individual thinking (Bower and Morrow 1991). The experts tend to recount their professional opinions with narratives that have a causal structure. The causal mental model is thus an individual’s interpretation of the institutional rules that constrain their decisions.

Having the above premise, we can say that the main institutional argument of public policy is that the actions of decision makers are largely determined by a feedback between institutions and the mental models of these decision makers. Nowadays, among the experts, the global consensus favors the efficiency of market economy; therefore this consensus leads to adopting the institutions of the capitalist system. As these institutions have proven their legitimacy for an efficient economic system, in return, their feedback influences the decision makers’ mindset. Accordingly the predominant of institutional order in societies prioritizes short term economics achievement over long term sustainability and system stability. It persuades decision makers to adopt cognitively inharmonious mental models in which economic efficiency achievement values higher than socio-economic harmony for the society.  While thinking that long term concerns should guide the public policy decisions, the mental models of decision makers focus only on economic concerns that, they believe, could destabilize the social system in shorter term. In the end, the short term economic concerns will determine which policies will be implemented. There is no way to get out of the link between mental models and institutions and they together constitute the decision making process.

Cognitive scientists assert that the more the formal institutions dominate the actions of decision makers, the stronger the cognitive dissonance they experience; but the stronger their cognitive dissonance, the more decision makers try to reduce it by adhering to the existing institutional order. They also explain that the individually conceived mental models form the building blocks for determining expert’s socially constructed reality of the issues.

The mental models than can be observed in experts’ narratives are complex causal networks containing both normative and factual statements which are reflected in the institutions and then influence the public policy decisions.  

Can demographic force determine demand side or supply side economic policy?

By Shahab Sabahi – Energy and Environment for Development – Research Group

Developed countries once praised themselves for creating robust economic growth. They pronounced that their success had stemmed from innovative monetary and fiscal policies. They encouraged other nations to adopt their ideas through IMF (international monetary fund). In reality, it turned out that socio-economic system did not really work out the ways policy had desired (e.g. Asia crisis in the 90s). Socio-economic system is a complex dynamic system. Its emergent property always manifests that planning can do little for taking the system in a desirable trajectory.  For example, in developed countries, the Great Recession was primarily caused by the collapse in economic demand as 80 million “baby-boomers” born between 1946 and 1964 moved out of their peak spending years in their mid-30s to mid-50s and into retirement in their late 50s and early 60s. In the US, the government tried to resuscitate this demographically shrinking demand with spending $7.6 trillion on Keynesian demand-side stimulus over the last five years. With only 23 million born between 1995 and 2012, this population is just too small for demand-side stimulus to revive the economy. Now the government faces high unemployed people with a budget deficit, and further needs to fund the baby-boomer’s retirement. Under this circumstance, will really demand-side stimulus work?

Our world today is different from the time of the Great Depression. To tackle the great depression, politicians borrowed the idea of Keynesian “demand-side” economics from Great Britain. Demand-side economics argues that in the “short-run” productive activity is influenced by aggregate demand (total spending in the economy) and that aggregate demand may not always equal aggregate supply (the total productive capacity of the economy). Therefore, governments set a demand goal through targeted spending, that has led to short-term growth since 1948.  

Studies demonstrate that 50% of all durable (cars and houses) and non-durable (food and clothing) expenditures are directly related to household demographics. Spending tends to peak as families grow and people reach their mid-30s to mid-50s. Then spending declines rapidly after the mid-50s.

In the 80s when the US switched to supply-side economic policy, the first baby-boomers born in 1946 were just turning 35 years old. By the time those first baby-boomers hit 55 in 2001, the NASDAQ over-the-counter index of growth stocks had risen 2600%, from 190 to over 5000. As the boomers hit 55 and begin to retire through 2019, only 30% as many generation members will replace them in the work force.

Leftist politicians advocate demand-side economics, as they get to look busy spending lots of money creating “demand” for the crony capitalism system. But as we have been observing, governments have been at the edge of bankruptcy cliff long before politicians can “create” enough demand to replace the shrinking consumption spending as the baby-boomers continue to rapidly retire. On the other hand, rightists try to promote a supply-side economics, since these sorts of policies believed once to encourage long-term economic growth.

Now developed countries are either relatively in national debt and recently suffered a credit downgrade (like the US) or suffer low growth. Also, in the theoretical sphere, there is no policy option but supply-side, therefore governments tend to return to supply-side economics to encourage growth. Perhaps governments can encourage population growth policies. 

Break away from obsolete monetary policy instruments (Orthodox school of thought)

By Shahab Sabahi – Energy and Environment for Development – Research Group

 Since July 2007 and particularly June 2011 onwards, the stock market in the US is undervalued. Stock’s prices are lower than the estimate of their fair value. It raises the questions “why the investors’ expectations are so low while real yields are negative” and “why the decrease in interest rates have not produce the increase in investments expected by the central bank”.

It can be argued around investments decisions behaviors. They are based on cost of capital of which interest rates are just one part. The other part, the cost of equity is so high that it takes promising exceptional high rate of return on capital to invest. In a world with uncertainty and complexity as the dominants factors, these investments are difficult to find. It is quite different from a probabilistic environment. In a probabilistic environment businesses can simulate business models with the increasing supply of data. However in the presence of complex systems where, interdependence, connectedness, diversity, and adaptation/learning rule, additional data does not help. In such an environment, businesses find hard, even with data analysis, to distinguish the market signal from the noise. We now face a complex world rather than a complicated one. A complex system stands between order and chaos. A complex system produces non-periodic patterns and emergent structures and functionalities. We should not expect a reduction in the cost of capital under the existing regulatory systems. Even if the real interest rates continue to decrease, businesses should overcome the uncertainty and the complexity of new investments. It is the real cost of capital in the present competitive environment.

Demand for higher cost of equity will promote the notion of rent seeking and short termism.  The world will encounter poor quality and high risky investments. Unfortunately our regulatory systems are still practicing traditional monetary policy. The regulatory systems have not come up with new innovative instruments and not prepared for addressing our today’s real challenges.