1 INTRODUCTION AND BACKGROUND
By recognizing the dual role of wages – as costs of production and sources of aggregate demand – neo-Kaleckian models have made an extremely important contribution to short-run macroeconomic analysis. In a closed-economy set-up with mark-up pricing, involuntary unemployment, unutilized capacity, and nominal wage stickiness, a redistribution of national income from capitalists to workers – who save less, on average – may generate additional spending and demand. If firms respond by increasing capacity utilization, output rises. Insofar as investment responds positively to expected future demand, higher utilization boosts accumulation given the profit share. Thus, growth in a closed demand-driven capitalist economy could be wage-led barring a strong profit-share effect on desired investment. Other work, however, has shown that growth is much less likely to be wage-led in an open economy. This is because while redistribution towards workers boosts consumption demand, it simultaneously reduces external demand by making the domestic good less competitive in international markets.
Blecker (1989) investigated this issue in an open economy ‘imperfect substitutes’ framework by introducing a flexible mark-up factor over average variable costs. Depending on the specification of the mark-up, any increase in the real wage is partially or fully passed through to the export price, making domestic goods less competitive internationally. This counters any positive effects on growth through increased utilization and investment. Thus, if the Marshall–Lerner condition is satisfied, open-economy considerations constrain the room for wage-led growth. Even an economy that is wage-led in the absence of international trade can transform into a profit-led one if a decline in real wages boosts international demand adequately to offset the fall in domestic absorption. However, this kind of growth has a ‘beggar-thy-neighbor’ aspect to it as it originates from one country ‘stealing’ demand from another. The rise in demand for the wage-lowering country, in other words, plays out in a zero-sum environment where one country benefits at the expense of the other. How is the analysis affected if we take the whole global economy as our unit of analysis?
Some recent literature has argued that since the world as a whole is a closed economy, global growth is likely to be wage-led. Put differently, since the constraint on export-led growth in an imperfect substitutes framework arises from the fact that one country runs trade surpluses at the expense of the other, and since the planet as a whole cannot run trade imbalances, the issues raised in an open-economy context are not relevant, and the global economy is highly likely to experience wage-led demand and growth. Lavoie and Hein (2015, p. 8) point out, for instance, that ‘at the level of planet earth, since net exports are zero by definition, the only reasonable strategy for the expansion of aggregate demand is to pursue a strategy of wage-led growth, that is, a strategy that is favourable to the labour force.’ Similarly, Onaran (2016, p. 464) observes that ‘even if there are some countries that are profit-led, the global economy as a whole is wage-led because the world is a closed economy. This makes intuitive sense, because planet Earth is a closed economy – at least as long as we do not trade with Mars!’
It is not clear, however, that the conclusion follows from the premise. The relevant issue is the presence of trade imbalances within the planet, that is, between countries. As long as countries differ along the relevant dimensions (saving rates, levels of capacity utilization, resource scarcity, consumer behavior, etc.), global demand as a whole can be either wage-led or profit-led, even in the absence of beggar-thy-neighbor effects. The same observations apply with even greater force to global growth. The fact that the planet as a whole does not run trade surpluses or deficits against itself is not central.
To put the point across starkly, suppose that the world consists of two countries that are identical in size and every other aspect except that one country produces its own investment goods but imports all its consumption goods from the other country, whereas the other country is self-sufficient in consumption goods. Then a redistribution towards profits in the first country increases investment spending without affecting the (non-existent) consumer demand for the domestic good. Utilization rises as a result, and demand in that country is profit-led. Moreover, the boost in utilization increases consumer demand for the second country's goods, increasing utilization there as well. The world as a whole then appears to be profit-led thanks to differences in consumer demand for the goods produced in the two countries. Note that this happens in spite of the appearance of a trade surplus in one country and a trade deficit in the other.
This paper explores the conditions under which the global economy as a whole could experience wage- or profit-led demand and growth in the short run. I start with a simple framework where the world consists of two countries and both countries are exactly identical in terms of the level of capital stocks, saving, investment and consumption behavior, and income distribution. Both countries are capital abundant in the sense that a lack of capital does not constrain production, and capacity utilization varies in response to demand. Employing this framework, I first show that, even in a zero-sum, beggar-thy-neighbor world, the nature of world demand is not independent of constituent country characteristics. I do this by demonstrating the effects of relative price changes given distributional shares, and, in the presence of biases in consumption demand for goods produced in different countries. Next, I show that, even if we remove beggar-thy-neighbor effects by assuming constant relative prices, the nature of world demand and growth continues to depend on constituent country characteristics. Again, I do this by demonstrating the effects of biases in consumption patterns. In particular, I show that, even in this boiled-down set-up, global demand could be either profit-led or wage-led, while the nature of the demand regime within each country depends on global consumption behavior via repercussion effects. For example, if global consumption is skewed heavily towards the good produced by one country, then the other country will tend to have profit-led demand. The intuition is simple: if the good produced by a country is only used as an investment good, then any global redistribution towards profits necessarily increases demand for that good, regardless of the nature of the demand regime in the other country.
These simple exercises show that merely considering the global economy as a whole does not make wage-led growth more likely. The global economy is the sum of its parts. When divided into two equal parts, the planet as a whole is wage-led only if either: (i) both economies are wage-led, or (ii) if one economy is profit-led, the other economy is very strongly wage-led. Thus, as long as it is true that, as suggested by empirical studies, at least some countries have profit-led growth, one cannot make a general claim about the planet as a whole being wage-led.
Finally, I extend the model to reintroduce beggar-thy-neighbor effects by employing a more conventional structuralist North–South closure, with the South modeled as a capital-constrained economy with an exogenously fixed real wage. I show that the possibility of global wage-led growth is more limited in such a set-up. Intuitively, a global redistribution towards wages now lowers investment in the South without affecting capacity utilization, while possibly raising the latter in the North if it has wage-led demand.
In sum, the global economy can be either wage-led or profit-led. The fact that the globe as a whole has balanced trade is not the decisive factor one way or another.
To the best of my knowledge, one other paper has theoretically explored related issues in a two-country framework. 1 Von Arnim et al. (2014) analyse the effects of redistribution in a country when it interacts with the rest of the world as a large economy. Analysing a two-country world with varying combinations of wage-led and growth-led economies, they show that redistribution in a country could raise global demand, even though it may lower relative growth for that country. The fact that one country can derive benefits from redistribution in another country gives rise to a possible fallacy of composition. 2 Due to the nature of their model, von Arnim et al. (2014) cannot explore the effects of differences between countries analytically and have to resort to numerical simulation. More importantly, the relevant thought exercise for our purposes would involve the global effects of redistribution across the world rather than in one country. This is because the argument that I explore in this paper is about whether the closed nature of the world as a whole makes wage-led growth more likely. Investigating this question requires analysing the comparative statics of redistribution that is global in nature. The analysis here, in other words, does not contradict or confirm that by von Arnim et al. (2014); rather, it addresses a different set of questions.
2 A SIMPLE TWO-COUNTRY MODEL
This section develops a two-country framework. It starts with the simplest case in Section 2.1, where both countries are exactly identical in terms of the level of capital stocks, saving, investment and consumption behavior, and income distribution, and, in Section 2.2, explores the (beggar-thy-neighbor) effects of relative price changes caused by nominal wage or exchange-rate changes. Only the (internationally identical) preference for one good or the other breaks the symmetry. The main conclusion is that, even in this boiled-down set-up, the nature of world demand and capital growth are not independent of constituent country characteristics. Next, Section 2.3 shows that, even if we eliminate beggar-thy-neighbor effects by assuming constant relative prices, the evolution of world demand and growth in response to distributional changes continues to depend on constituent country characteristics. Finally, Section 2.4 reintroduces relative price effects to show that earlier findings continue to apply in a more traditional structuralist set-up, where the North has varying capacity utilization while adjustment in the capital-scarce South takes place through relative price movements.
2.1 When both countries are capacity-constrained
Let's start by defining macroeconomic behavior. Consider two countries, say North and South, that are similar in the sense that neither economy has a capital constraint. Each produces a good – called good
Consumers in each country spend a fraction of their income on their own good and the remainder on the foreign good. Only profit income is saved. Utilization is proxied by outputs as ratios of capital stocks (for example,
The share of consumption of each good (
The two goods market conditions in excess demand form follow:
2.2 Beggar-thy-neighbor effects
Before we explore the effects of redistribution on global income and demand, let's take a quick look at the consequences of a relative price change that leaves distribution unchanged. Does the world economy as a whole experience changes in demand as a result?
An increase in
Now suppose there is a nominal devaluation in the North. The effect will be to raise
Consider first the case where the two countries are exactly identical in the sense that not only do the assumptions listed under (10) hold, but that, in addition, each country divides its consumption expenditure equally between the two goods (that is,
The beggar-thy-neighbor effects cancel out between the two regions so that things play out at the global level as a zero-sum game. 7 In such a world, relative price changes have an effect only at the country level. This is the case that one has in mind when one expects the world as a whole to act as a closed economy.
Next, consider the case where global consumption demand is extremely skewed towards the
The overall effect on utilization is negative even though substitution effects cancel out at the global level. Intuitively, this is because of the asymmetry in global consumption demand, as a result of which the negative valuation effect of the relative price change on Northern imports lowers global utilization.
Not surprisingly, the mirror-image result holds when global consumption demand is skewed towards the
Global consumption patterns matter. A bias towards consumption for any of the two goods leads to changes in global utilization in response to relative price changes. Unless its constituents are exactly identical, the world as a unit does not act like a closed economy. 8
The difference considered here between the economies is that of global consumer preferences over the two goods. One would, of course, reach similar conclusions were one to explore other differences, such as those in saving rates, size, initial utilization rates, or distributional shares.
The next sections builds on the intuition derived here; I will continue to explore the effects of differences in global consumption of the two goods, but the thought experiments will now involve global distributional changes.
2.3 Global redistribution toward wages
Next, suppose there is a redistribution of income, globally, from profits to wages. In order to limit the number of moving parts, I will constrain the analysis to redistributions involving no changes in relative prices. 9 That is, I will exclude the beggar-thy-neighbor effects of relative price changes. As demonstrated in Section 2.2, the main conclusion drawn from our exercise, that is, that the nature of world demand and growth is not independent of the constituent economies, is robust to relative price changes.
First, a look at the partial effects in each market:
Redistribution away from profits raises consumption spending in both countries. For either country, if this increase along with the boost to exports (due to repercussion effects) is sufficient to dominate the decline in investment due to the lower profit share, then demand in that country is wage-led; otherwise it is profit-led. The nature of demand is influenced by the initial distribution of world capital stock, global consumer preferences, and, of course, more standard factors such as saving and investment behavior. In order to anticipate later results, notice that the more world demand is skewed towards a country's own products, the more likely it is to have wage-led demand.
The world in this framework is essentially one large economy, except that there is a line running through it that divides it equally so that one good is produced in each part. In this world, one cannot have relative price effects from global redistribution since an identical change in the mark-up factor across the world will leave
Note that both bracketed terms in the denominators are positive by the traditional Keynesian stability conditions. 10
Output in either economy could either be wage-led or profit-led. The outcome, as we shall see shortly, depends crucially on global consumption behavior in terms of composition. In order to dig deeper, let's explore some interesting cases.
Skewed global preferences
Consider first the case where global consumption demand is extremely skewed towards the
It is clear, however, that the South is less likely to be wage-led than if it were a closed economy. This is because of the harm to exports that redistribution causes, even when beggar-thy-neighbor effects are absent by construction. To see this more clearly, we can decompose the numerator of the expression above into two terms, such that wage-led demand requires that:
Now the second term (in square brackets) is positive if the South is wage-led, that is,
What about global demand?
A sufficient condition for global demand to be wage-led is that both countries be wage-led. Since that is not true in this case – recall that the North is unambiguously profit-led – the South should be sufficiently wage-led to offset the profit-led demand in the North. Mathematically this condition boils down to:
The left-hand side is the condition for the South to be profit- or wage-led (with the conditions summarized by equation (10) imposed on equation (12) and
Table 2 summarizes the results for ease of comparison between this and subsequent sections. Since the two countries are symmetric at this point, the same analysis would apply in mirror-image form if global consumer preferences were skewed towards the
Symmetric global preferences
Next, consider the case where global consumers devote an equal proportion of their spending to either good, that is,
Not surprisingly, the condition for utilization to rise in response to global redistribution toward wages is the same in each country. Moreover, it is the same as the condition for global demand to be wage-led in the presence of skewed preferences (see equation (16) above). For the globe as a whole, the change in utilization is given by:
Let's now turn our focus to the nature of effects on accumulation rather than demand in the short run and over time. Equations (5) and (6) have already defined investment behavior. Since the economies start with identical levels of capital stocks, the immediate change in the global rate of accumulation is given by
We are now in a position to revisit our thought experiment involving global redistribution. Once again, we will contrast scenarios with different global consumption behaviors.
Skewed global preferences
Recall that, in this case, the
As in the case of utilization, the effect on Southern accumulation is less clear. Indeed, not unexpectedly, the condition for wage-led growth is more stringent than that for wage-led demand. This is because, even if demand is wage-led, the resulting boost to investment must dominate the direct effect of a lower profit share on investment to make growth wage-led.
A positive effect on global accumulation requires, as a sufficient condition, that investment in both countries be more sensitive to utilization than to the profit share (that is,
Symmetric global preferences
Recall that this is the case where consumers worldwide allocate an equal share of their consumption expenditures to each good (
The effect on investment in each country is determined by the cumulative effect in the two countries. A sufficient condition for global growth to be wage-led is that the utilization elasticity of investment in each country be less than the profit share elasticity. Exactly the same condition ensures that global growth is wage-led. A less stringent necessary condition is that at least one country have wage-led growth. If one of the countries has a profit-led growth regime, the other must have a strongly wage-led regime. The world as a whole may be either wage- or profit-led as long as the two countries differ in their regimes.
2.4 Extension: the traditional structuralist North–South closure
Structuralist models have typically employed a different closure for North–South models whereby capacity utilization adjusts in response to disequilibria in the industrialized North while relative prices (or the terms of trade) adjust in a capacity-constrained South.
As we see below, this closure makes global wage-led growth less likely. The two goods market equilibrium conditions are largely similar to what we had before (see equations (7) and (8)), with the difference that, with relative price adjustment reintroduced, investment in the South is no longer a function of capacity utilization (which is normalized to unity for convenience). Assuming again that
Notice that, with full utilization, the profit share in the South is the same as the profit rate. Also, it may be useful to note that although output cannot be wage- or profit-led with full utilization, demand can, since only capitalists save.
We can now analyse our earlier distributional thought experiment employing the more traditional structuralist closure.
2.4.1 Global redistribution again
To carry out the analysis, we will have to separate movements in relative prices due to excess demand or supply in the goods markets from those due to policy-induced redistribution. Recall that, with exogenous profit shares in both regions, a redistribution towards wages requires a decline in the mark-up. Since the reduction in the mark-up factor is the same in both regions – our thought experiment involves identical redistribution across the world –
As earlier, first a look at the partial effects:
Global consumer preferences skewed towards the S-good
Again, first the case where global consumption demand is extremely skewed towards the
Recall that, in Section 2.3, where both regions had excess capacity, demand was unambiguously profit-led in this scenario. The reason was that, with no consumption of the Northern good, any reduction in the profit share will result only in lower investment demand. Now things are more ambiguous. Even though no Northern goods are initially being demanded for consumption, the redistribution may lead to a rise in the equilibrium value of
Symmetric global preferences
Next, consider the case where
Again, notice that, if
Global consumer preferences skewed towards the N-good
Now the case where
How is growth (as opposed to demand) affected by redistribution in this case, where the South has full capacity utilization? Since it is global growth that we are interested in, let's take a look at the expressions for aggregated global growth. Since growth in the South is now only a function of the profit rate (share), intuitively one would expect the likelihood of global wage-led growth to be lower in this case. This is indeed the main outcome of the analysis below.
Global consumer preferences skewed towards the S-good
Recall that, in the case where global preferences are skewed, so that
The term in the first set of square brackets in the numerator is the same as in the case where both regions had excess capacity (see equation (19)). The second pair of square brackets in the denominator contain the additional positive term that makes wage-led growth less likely even if investment is more responsive to the profit share than to utilization.
Symmetric global preferences
With symmetric global preferences, that is,
Global consumer preferences skewed towards the N-good
The expression derived in this case, that is, when
Unlike the case where both regions had excess capacity, it is no longer enough for both countries to be wage-led to make global growth wage-led. Instead, the additional term
In sum, in all three cases considered, world growth is less likely to be wage-led when one country is capacity-constrained.
3 CONCLUDING REMARKS
Do open-economy arguments pointing out the constraints to wage-led demand and capital growth become irrelevant once we consider the fact that the planet as a whole is a closed system? This paper zooms in on differences in consumption demand to illustrate that this is not the case. Even in a closed world economy, where both countries have excess capacity and underutilized resources, the world as a whole could easily be profit-led. This is because, as long as there is a line dividing the world into two countries that produce different goods, only one country needs to be profit-led in order for the world as a whole to be profit-led. The fact that global consumption of the two goods is not identical may indeed push demand regimes in some countries in the direction of being profit-led.
The lesson extends to a multi-country world, where again it's possible at least in theory for world demand and growth to be profit-led if even one or a few countries have that feature. Furthermore, the likelihood of world growth being profit-led increases if one incorporates the typical structuralist assumption that the South is capital-constrained, or that the Southern countries are price-takers in international tradable markets. 15 That the world economy is a closed system is not the central issue as long as individual countries have trade imbalances, repercuss, and/or are not exactly alike in all respects.
Onaran and Galanis (2012) investigate a sample of 16 G20 countries and find that growth in some is wage-led while in others it is profit-led. Their study is a purely empirical exercise, however, and focuses on simulating the effects of redistribution based on coefficients derived from individual countries. An analysis of the strengths and weaknesses of their empirical approach is beyond the scope of this paper. See Skott (2017) for a discussion.
Notice that these shares can be fixed by simply assuming that
In the present framework, this means exploring the effects of a nominal change in the wage or the exchange rate.
Notice that the fact that the two countries are identical in terms of size allows us to add up the effects on the two rates of utilization to get the global effect.
Notice, however, that substitution effects (as captured by the variable
Implicitly this requires that the proportional rise in the mark-up factor is identical in the two countries.
More specifically, stability requires that
Note that, with
Thus, the North starts out with a trade deficit while the South starts out with a surplus. Intuitively, the North buys all its consumer goods from the South. A redistribution towards wages has an ambiguous effect on the Northern trade balance, although it continues to have a trade deficit (and the South continues to have an equivalent trade surplus). Mathematically,
Lavoie, Marc and Eckhard Hein (2015), ‘Going from a low to a high employment equilibrium,’ Working Paper 144, Düsseldorf: Macroeconomic Policy Institute.
Onaran, O. and G. Galanis (2012), ‘Is aggregate demand wage-led or profit-led? National and global effects,’ Conditions of Work and Employment Series 40, Geneva: International Labour Office.
Palley Thomas , '‘Export-led growth: evidence of developing country crowding-out,’', in P. Arestis, M. Baddeley and J. McCombie (eds), Globalization, Regionalism, and Economic Activity , (Edward Elgar Publishing, Cheltenham, UK and Northampton, MA 2003 ) 175 - 197 .
Razmi, Arslan - Department of Economics, University of Massachusetts Amherst, USA