Is it supply that drives an economy or demand? Such was the question asked by Keynesian economics blogger and Bloomberg columnist Noah Smith. Smith often raises issues that enlighten us on the differences (and similarities) between mainstream neoclassical and Keynesian economics, and, in so doing, where Keynesian theory and policy differs from a Marxian analysis.
In a recent article, Smith questioned the traditional neoclassical view of economic growth, namely that real GDP expansion depends on employment plus productivity (output per employee). This neoclassical view, says Smith, means that, while Keynesian monetary and fiscal policies might get an economy out of a slump, they can do little to raise long-term productivity growth. But he begs to differ.
This ‘supply-side view’ is inadequate, says Smith. Boosting demand with Keynesian-style measures of cheap money and government spending could create the conditions for raising output permanently onto a new and higher trajectory: “it may be time to momentarily step away from economic orthodoxy and look at demand-based policies to help boost productivity.” There is a ‘demand-side’ view of long-term economic growth.
Smith cites Verdoorn’s law as relevant to this thesis: “Dutch economist Petrus Johannes Verdoorn describes a correlation between output and productivity — when growth is faster, productivity also grows faster. You can see this correlation in the data.” This, claims Smith, “leaves open the tantalizing possibility that the reverse is happening — that high levels of aggregate demand also drive up productivity.” So, when there is a boom in demand, this leads to more sales and output and encourages companies to invest more and, as a result, this leads to rising productivity. Thus demand creates its own supply – the reverse of Say’s law, as promoted by Ricardian and neoclassical economics, that supply creates its own demand.
So has neoclassical economics got things back to front and all we need to do in economic policy is to keep “running the economy hot, through continued monetary and fiscal stimulus”? Well, the first thing to say is that Smith’s reference to Verdoorn’s law to support his argument that Keynesian-style demand boosts will sustain increased productivity is misleading. Actually, all that Verdoorn shows is that “in the long run a change in the volume of production, say about 10 per cent, tends to be associated with an average increase in labor productivity of 4.5 per cent.” This correlation proves nothing about causation. So output and productivity growth are correlated – surprise! – but is it total ‘demand’ or output growth that stimulates productivity growth, or vice versa?
Smith cites research that is supposed to show the causal connection from demand to supply, but when you check that research you find that the authors cited, Iván Kataryniuk and Jaime Martínez-Martín, conclude: “some of the deterioration of the TFP (productivity – MR) growth outlook in recent years may be explained by a negative business cycle, but structural weaknesses remain behind the slowdown in medium-term growth, especially for emerging countries.” So it’s not demand that is the main cause of long-term productivity growth.
From a Marxist view, what’s missing from this debate, as always between mainstream neoclassical and Keynesian disputes, is profit and profitability. Sure, it is obvious that when an economy is booming and demand for goods is strong, then companies will usually increase investment in new technology as well as employing more workers (but I say ‘usually’, because in this Long Depression, it seems companies have increasingly kept cash or invested in financial assets ie their own shares, rather than in productive assets).
An expanding economy leads to a virtuous circle of growth, investment and even productivity growth. But that virtuous circle eventually turns into a vicious circle of slump, a collapse in investment and output that cannot be corrected by easy money or fiscal stimulus. Why does a boom turn into slump? The Marxist view is not because of some unexplained shock to the harmonious development of the market economy (the neoclassical view) or some unexplained change in the ‘animal spirits’ of entrepreneurs to invest (the Keynesian view). It is because, in a profit-making economy (i.e. capitalism), profitability and profits fall back. When that happens, as it will at recurring intervals, then output, investment and productivity will follow. There is a profit cycle.
The Marxian view argues that it is the Keynesian view that is back to front. Supply leads demand, not vice versa. But this is not the same as the neoclassical view that supply creates its own demand (Say’s law). For Marx, Say’s law was a fallacy. In a monetary economy, there is always the possibility of a breakdown (both in time and inclination) between sale for money and purchase with money. Hoarding of money can cause a collapse of sales and purchases. But what causes that possibility to become a probability or reality? For Marx, it is a fall in the profitability of capital.
In the Keynesian world of macro-identities, National Income equals National Expenditure. National income is composed of wages and profits and National Expenditure is composed of Consumption and Investment.
NI = NE can be decomposed to
Wages +Profits = Consumption + Investment
If we assume that workers do not save but spend all their wages, then the equation becomes:
Profits = Investment
This is an identity that does not reveal the causal direction. The Keynesian view is that Investment (demand) creates Profits (supply). But the evidence is against Noah Smith and the Keynesians. The body of empirical evidence is that changes in profitability and profits lead to changes in investment. And it is this that decides when there are cyclical booms and slumps and also the long-term growth path of a capitalist economy
Smith says “much more research is needed” to see whether demand creates supply or vice versa. But the research is already there. It is well established that ‘easy money’ (low interest rates and ‘quantitative easing’) won’t work in restoring long-term productivity growth – as Keynes also concluded in the 1930s and the evidence of the last ten years confirms. The search for some ‘natural rate of interest’ that establishes full employment and maximum potential output growth is a mirage (reaching for the stars).
And studies (including my own) of the (Keynesian) ‘multiplier’ effect of boosting government spending or running the economy ‘hot’ (Smith) is much weaker (and even inverse in direction) than the impact of the profitability of capital on growth and productivity.
Clearly in this Long Depression, hysteresis is in operation, namely that low growth in output and profits has pushed investment and productivity growth onto a permanently lower trajectory. But this is not the result of a lack of ‘effective demand’ per se, but comes from the failure of the profitability of capital to return to pre-2008 levels and/or to grow fast enough.
Smith may suggest that neoclassical theory has got it ‘back to front’. But so has Keynesian theory.
Michael Roberts Blog 
“Thus demand creates its own supply – the reverse of Say’s law, as promoted by Ricardian and neoclassical economics, that supply creates its own demand.”
Actually, Keynesianism, in this specific case, is not the reverse of Say’s Law: it IS Say’s Law applied to a fiat currency system (i.e. a non-Gold Standard world). That highlights the fact that Keynesianism is not really a “theory”, but a doctrine or school, if you prefer.
Productivity. Discussions regarding this have always left me with the question: Productivity. By what measure?
In capitalism this must mean by what they call ‘value’. That is the net revenue ($) produced divided by the # of workers’ per unit of time. And an increase in such would mean more of this ‘value’ ($) produced per unit of labor-value (wage).
In socialism this must mean by what measure? The answer must be value, i.e.. by decreasing the labor-time necessary to producing an object per unit of labor-time.
So, shouldn’t we distinguish between these two when we speak of productivity.
JAI
Well said. Yes falling prices under socialism, because they measure labour time directly will be an automatic indicator of labour productivity. However, prices no longer measure value here because value is synonymous with indirect labour time. Value only exists in a society where the labour of the individual only becomes part of the labour of society through first having to be exchanged, that is indirectly through exchange. It is this reality that allows prices and values to diverge because the money received may not equate to the value given up. Realised value is a moveable feast throughout the business cycle, it underestimates productivity on the down side of the cycle and overestimates it on the rising side, though this averages out over the cycle. Finally, the statistical bureaus use deflators designed to bring price rises back to zero, but why zero when prices are actually falling. Hence their deflators tend to underestimate volumes, thus productivity.
Thank you for your comments. Much to be understood there.
As I see it, productivity has two definitions: in capitalist production ‘productivity’ is the measure of ‘value’-added, i.e. the net last living labors-added contribution to the exchange-values of previously produced means of production (ppmofp) worked up and ready for market; and, secondly, in all production, productivity can be understood as the measure of the change in labor-time necessary to produce a product as reckoned in terms of units of AHL-t (abstract (or societal average) human labor-time). While the capitalist recognizes only the first; as good communists, we understand productivity in terms of the latter, the lengthening or the shortening of the necessary amount of AHL-t. Both of these are relativities, before/after comparisons of labor-times.
As with ‘productivity’ the concept’ value’ finds bifurcated meanings within itself of itself.
In the first place there is, in commodity production, a ‘social value’ or ‘value-added’, which are those additions to the exchange value of the (ppmofp) provided by more labors being expended upon them. In capitalism this ‘value-added’ divides itself into two parts: wage (v) and surplus-value (sv). It is this last, his net, sv, by which the capitalist calculates his ‘productivity’ measures. This is the ‘value’ of which you aptly wrote that “…only exists in a society where the labour of the individual only becomes part of the labour of society through first having to be exchanged”.
Secondly, value can be understood as a scientific measure of the total additional labor-time added to the values of the (ppmofp), again, in terms of AHL-t. Longer or shorter necessary labor-times, these are absolute measures of ‘worth’.
The first, ‘value-added’, will cease to be a measure with the cessation of production based upon exchange. The second, value, will exist as long as production does as the measure of total necessary labor-time and thereby useful as a scientific measure of efficiency. Of this latter, Marx wrote:
“…after the abolition of the capitalist mode of production, but still retaining social production, the determination of value continues to prevail in the sense that the regulation of labour-time and the distribution of social labour among the various production groups, ultimately the book-keeping encompassing all this, become more essential than ever.” Vol 3. Chap 49.
The second value you refer to is the actual cost of production. In all societies based on exchange, i.e. one divided by production and only united through exchange, the actual cost of production takes the form of the value of the products being exchanged. Socialism does not end the “cost of production” only the value form it takes. Under capitalism the highest expression of value is market value, which is the weighted average labour time. (Chapter 10, Volume 3). Under socialism actual cost is nothing other than the weighted average labour time needed to produce a product, because the total time spent on that product divided by the number of products will always yield the weighted average labour time, and, not the simple average or abstract labour time.
The distinction you make between a capitalist and a socialist commodity’s “value form” is so subtle as almost to be indistinguishable, since both assume a quantitative measurement of labor time for purposes of efficient use of labor power (productivity). It pointless to theorize about labor and “value” under “communism” if merely imagining a viable socialist state is so problematic. No doubt the socialist regime you assume is transitional and hierarchical (state directed) in structure. I’ll try to make concrete and explicit what I think you imply by your subtle distinction between the capitalist and socialist forms of labor time.
A revolution overturning the capitalist system, for instance ,even in the former Soviet Union and China necessarily overturn capital’s social relation and supplanting capitalism’s production for private profit and accumulation to production for social needs and accumulation of the social surplus by the “workers’ state”. Needless to say, ambiguities abound in such revolutionary “socialist” states, particularly underdeveloped ones. Nevertheless, in both Russia and China, initially, production of goods was determined by the immediate needs of society (production of use values) rather than production for the profit (surplus products accumulated by the state), which would have required the employment extant, most “efficient” means of production (including “labor power”) employee by the old comprador order. Consequently, the productivity of labor and GNP in both countries dropped immediately after the revolution, but began to rise after the restructuring of the mode of production, prioritizing social need.
In other words, under any revolutionary socialist regime, the calculation of labor time, as a unit of value is socialized and becomes ancillary to the production of use values for need (the reverse of capitalism). The very concept of the productivity of labor itself is transformed along with the nature of the products produced. Socialist productive labor For instance, in US or England, much of the most profitable and efficient enterprises actually produce mere waste and pollution. Under a socialist regime they’d have to be deconstructed, possibly replaced by hands on highly skilled, humanely inefficient labor (a much easier process in a fully developed country than in a “backward” one victimized by the imperial system). Cuba lost its private sugar plantations and gained skilled medical care as an export.The Vietnamese had to dismantle much of the efficient, highly profitable colonial plantations to feed itself (on land later poisoned by the US). Small, independent farmer or cooperative agriculture will have to be reintroduced in Africa for the health of the land and to employ and feed Africa’s vast army of reserve (and permanently unemployed) labor.
Needless to say, the overwhelming economic and military forces of imperialism have succeeded in establishing barbarism at the centers of capitalism, and in distorting and/or overturning most the initial attempts at establishing socialist modes of production in its ex-colonial peripheries. But the efficiencies of capitalist accumulation have turned out to be efficiencies of destruction and the chickens are coming home to roost.
Michael, could you replace this version with the one (full of typos) just posted?
The distinction you make between a capitalist and a socialist commodity’s “value form” is so subtle as almost to be indistinguishable one from the other, since both assume a quantitative measurement of labor time for purposes of efficient use of labor power (productivity). It is pointless to theorize about labor and “value” under “communism” if merely imagining a viable socialist state is so problematic. No doubt the socialist regime you assume is transitional and hierarchical (state directed) in structure. I’ll try to make concrete and explicit what I think you imply by your subtle distinction between the capitalist and socialist forms of labor time.
A revolution overturning the capitalist system, for instance, even in the former Soviet Union and China necessarily overturns capital’s social relation and supplants capitalism’s production for private profit and accumulation with production for social needs and accumulation of the social surplus by the “workers’ state”. Needless to say, ambiguities abound in such revolutionary “socialist” states, particularly underdeveloped ones. Nevertheless, in both Russia and China, initially, production of goods was determined by the immediate needs of society (production of use values) rather than production for the profit (surplus products accumulated by the state), which would have required the employment of extant, most “efficient” means of production (including “labor power”) employed by the old comprador order for its own and imperialist accumulation. Consequently, the productivity of labor and GNP in both countries dropped immediately after the revolution, but began to rise after the restructuring of the mode of production, prioritizing social need.
In other words, under any revolutionary socialist regime, the calculation of labor time, as a unit of value is socialized and becomes ancillary to the production of use values for need (the reverse of capitalism). The very concept of the productivity of labor itself is transformed along with the nature of the products produced. For instance, in US and England, much of the most profitable and efficient enterprises actually produce mere waste and pollution. Under a socialist regime they’d have to be deconstructed, possibly replaced by hands on highly skilled, humanely inefficient labor (a much easier process in a fully developed country than in a “backward” one victimized by the imperial system). Cuba lost its private sugar plantations and gained skilled medical care as an export.The Vietnamese had to dismantle much of the efficient, highly profitable colonial plantations to feed itself (on land later poisoned by the US). Small, independent farmers or cooperative agriculture will have to be reintroduced in Africa for the health of the land and to employ and feed Africa’s vast army of reserve (and permanently unemployed) labor.
If anybody has read either one of my muddled responses to Ucan’s clear and concise comments, please accept the apologies of a rather elderly writer, whose brains turn to pudding when sitting too long at a computer–an alien object that seems to have a mind of its own. The computer did it. …Yet a kind and patient reader might find a kind of coherence in both the original and the “edited” versions.
Dear Mr. Roberts,
this may be interesting for you: https://www.boeckler.de/pdf/v_2018_10_26_orhangazi.pdf
It is from this conference. i did not attend, just looked at the papers: https://www.boeckler.de/veranstaltung_imk_116391.htm
And did you recognize the UNCTAD studies about corporate rent seeking? I attach also the excel file. https://unctad.org/en/PublicationsLibrary/presspb2018d3_en.pdf
Best regards
Ralf Krämer
Bereich Wirtschaftspolitik
ver.di Bundesvorstand
Paula-Thiede-Ufer 10
10179 Berlin
Tel: +49 30 6956-1137
Fax: +49 180583734311137
Mobil: +49 151 14268540
E-Mail: ralf.kraemer@verdi.de
Internet: http://www.wipo.verdi.de
Dear Ralf, thanks for these references. Yes, I did see some of these papers and may comment on them in the few weeks. I have covered the issue of intangibles and investment previously here https://thenextrecession.wordpress.com/2017/12/10/capitalism-without-capital-or-capital-without-capitalism/
and also the issue of monopolistic rents here. https://thenextrecession.wordpress.com/2017/11/21/market-power-again/
Demand is always of psychological nature. It is apprehended as a need by the mind, which seeks to be fulfill. Supply, on the other hand, is always of objective nature. It is already realized as a commodity as soon as it comes to be.
Demand is endless, as the human mind within capitalism becomes accessory to the desires which perceives as coming from commodities. So, the only thing that drives the economy is the supply. Supply is only realized as a consequence of work. So, work is what drives the economy, disguised as supply.
In a rational society, we’d produce what we need. If it took less socially necessary labour time to do that, we could be happy with more leisure time to “invest” in our private lives.
Reblogged this on Solidarity Dynamics and commented:
Again, thank you Michael.To reinforce your key point about Keynesian (and most labor economists) fail to grasp hold of profits and profitability. First, most workers do understand the significance of profits and profitability, often intuitively out of day to day experience and sometimes (too rarely) through deeper collective study. Second, I have put this to a number of people recently: put 100 employers in a room listening to the Reserve Bank governor whinge about low wages and guess what they will be thinking about? Of course, what about my profits and my profitability? This is lost in the minds of just about all mainstream and other economic commentators in Australia. Workers understand what they do not.
“Hoarding of money can cause a collapse of sales and purchases. But what causes that possibility to become a probability or reality? For Marx, it is a fall in the profitability of capital.”
But this possibility (to hoard money) only exists if central bank allow it, if they want to they can devalue money capital by changing how much each dollar/euro/pound is backed up by government bonds. It get‘s harder at the zero bound, but in the US and the UK they did just that and unemployment was brought back down again. The ECB did a far worse job.
So why is productivity not rising? The main problem seems to be that new money bids up fictitious capital instead of being invested in real capital and the following wealth effect raises employment through consumption of low-productivity services.
All this is not separable from the problem of rent. Imagine an economy without rent, that is income from assets in fixed supply (be it naturally fixed supply like the site values of land, natural monopolies like networks or artificially fixed supply through intellectual property laws, zoning laws, borders.) Without assets in fixed supply fictitious capital (bidding up the present value of a future income stream) could only be based on old, already produced real capital. But if the price of real capital goes up, under conditions of real competition, new real capital would be produced, because new real capital could deliver the same income stream for a lower price, that is a higher rate of return.
So, the whole fictitious capital problem (like companies with market power buying back their own stock ) is based on the ability to invest in assets in fixed supply, which can’t stimulate investments in real production and can’t raise productivity. From this follows that to end the „production“ (the bidding up) of fictitious capital, rental income from assets in natural fixed supply should be taxed away and laws have to be changed to break up artificial fixed supply.
Another reason for low productivity is austerity. You could raise productivity through public investment. From Marxists you often hear, public investment is no solution for raising productivity because the debt burden will become unsustainable. But lots of governments have negative real interest rates, Germany has even negative nominal (!) interest rates. It could borrow money, invest in infrastructure and education while lowering its debts!
After having read your 2018 pub World in Crisis, looking for a present day validification, the second essay by Guglielmo is science at its best. Want to add that only by increasing rate of exploitation can there be increase in rate of profit. Here in Australia in Perth this palpable when ride on the public bus service. No only do you get a ride but also a fair ground experience. Not so enjoyable when you can’t with stand the enormous deaxcelleration forces and you break a leg. Ie bus drivers at extreme of increased exploitation, point is, it’s at breaking point. Alan Woodcraft AMWU RMD member Australian IST Solidarity.