Nonlinear Dynamics and Pseudo-Production Functions

Aggregate production functions are still widely used four decades after it was conceded that they could not be grounded in any plausible micro-foundations. This paper shows that aggregate production functions can always be made to work on any data that exhibits roughly constant wage shares, even when the underlying technology is non-neoclassical. But in so doing, they always pick up the accounting identity that underlies the data. This is demonstrated on both actual US data and a control data set derived from a fixed coefficient model with Harrod-neutral technical change and a persistent rate of unemployment. It is proved that one can generate an infinite number of fits, each of which gives a different reading of the rate of technical change. It follows that even when aggregate production functions appear to work at an empirical level, they provide no support for the neoclassical theory of aggregate production and distribution. On the contrary, the best of fits can utterly misrepresent the true underlying mechanisms of production, distribution, technical change, and growth.

"A Dynamic Approach to the Theory of Effective Demand"

This paper attempts to resituate the theory of effective demand within a dynamic nonequilibrium context. Existing theories of effective demand, which derive from the works of Keynes and Kalecki, are generally posed in static equilibrium terms. That is to say, they serve to define a given level of output which corresponds to the equilibrium point between aggregate demand and supply. We propose to generalize this analysis in three ways. First, we will extend the analysis to encompass a dynamic (i.e. moving) short run path of output, rather than a merely static level. Second, we will show that this dynamic short run path need not imply an equilibrium analysis, since it can arise from either stochastically sustained cycles or deterministic limit cycles. And third, we will prove that the preceding generalization of the theory of effective demand will allow us to solve a long standing problem in growth theory: namely, the puzzle surrounding the apparently intractable instability of warranted growth.

"Real Exchange Rates and the International Mobility of Capital"

This paper demonstrates that the terms of trade are determined by the equalization of profit rates across international regulating capitals, for socially determined national real wages. This provides a classical/Marxian basis for the explanation of real exchange rates, based on the same principle of absolute cost advantage which rules national prices. Large international flows of direct investment are not necessary for this result, since the international mobility of financial capital is sufficient. Such a determination of the terms of trade implies that international trade will generally give rise to persistent structural trade imbalances covered by endogenously generated capital flows which will fill any existing gaps in the overall balance of payments. It also implies that devaluations will not have a lasting effect on trade balances, unless they are also attended by fundamental changes in national real wages or productivities. Finally, it implies that neither the absolute nor the relative version of the Purchasing Power Parity hypothesis (PPP) will generally hold, with the exception that the relative version of PPP will appear to hold when a country experiences a relatively high inflation rate. Such patterns are well documented, and in contrast to comparative advantage or PPP theory, the present approach implies that the existing historical record is perfectly coherent. Empirical tests of the propositions advanced in this paper have been conducted elsewhere, with good results.

The Vast Majority Income (VMI): A New Measure of Global Inequality

GDP per capita is by far the most popular measure of international levels of development. It is fairly well understood and widely available across countries and time. But it is also recognized that GDP per capita is an imperfect proxy for important factors such as health, education and well-being. An alternative approach has been to work directly with the variables of concern, as in the UNDP Human Development Index (HDI). The HDI combines GDP per capita with life expectancy and schooling into a single composite index. But, the HDI is difficult to compile. Moreover, because it is an index, it cannot tell us about the absolute standard of living of the underlying population: it can only provide rankings of nations at any moment in time and changes in these rankings over time. It turns out that the rankings produced by the GDP per capita and the HDI are quite highly correlated. Given that GDP per capita also provides an absolute measure of income; it is understandable that it remains so popular. Both the GDP per capita and the HDI measures suffer from that fact that ?they are averages that conceal wide disparities in the overall population? (Kelley, 1991). As a result, it becomes necessary to either supplement these measures with information on distributional inequality as in the Gini coefficient, or to directly adjust GDP per capita and other variables for distributional variations. Sen (1976) derives (1-Gini) as the appropriate adjustment factor for real income. Since a higher inequality implies a lower (1-Gini), this penalizes regions or countries with higher inequalities. The 1993 HDI used this procedure to adjust GDP per capita in various countries. Subsequently, it was extended to encompass the variables in the HDI using discount factors based on the degrees of inequality in their specific distributions. Later, the index incorporated gender-based adjustments by discounting a country?s overall HDI according to the degree of gender-inequality (Hicks, 2004). The above measures of welfare will be re-examined in light of our own finding that inequality-discounted GDP per capita can be interpreted as a measure of the relative per capita income of the first eighty per cent of a nation?s population. This Policy Research Brief introduces a new measure of worldwide income and inequality, which we call the Vast Majority Income (VMI).GDP per capita is by far the most popular measure of international levels of development. It is fairly well understood and widely available across cou

"Explaining Long-Term Exchange Rate Behavior in the United States and Japan"

Conventional exchange rate models are based on the fundamental hypothesis that, in the long run, real exchange rates will move in such a way as to make countries equally competitive. Thus they assume that, in the long run, trade between countries will be roughly balanced. The difficulty in assessing expectations about the consequences of trade arrangements (such as NAFTA or the EEC) is that these models perform quite poorly at an empirical level, making them an unreliable guide to economic policy. To have a sound foundation for economic policy requires operating from a theoretically grounded explanation of exchange rates that works well across a spectrum of developed and developing countries. This paper applies the theoretical and empirical foundation developed in Shaikh (1980, 1991, 1995), and previously applied to Spain, Mexico, and Greece (Roman 1997; Ruiz-Napoles 1996; Antonopoulos 1997), to the explanation of the exchange rates of the United States and Japan. Such a framework implies that it is a country's competitive position, as measured by the real unit costs of its tradables, that determines its real exchange rate. This determination of real exchange rates through real unit costs provides a possible explanation for why trade imbalances remain persistent and a policy rule-of-thumb for sustainable exchange rates. The aim is to show that a theoretically grounded, empirically robust, explanation of real exchange rate movements can be constructed that also can be of practical use to researchers and policymakers.

Explaining the U.S. Trade Deficit

Levy Economics Institute Policy Not

"Measuring Capacity Utilization in OECD Countries: A Cointegration Method"

This paper derives measures of potential output and capacity utilization for a number of OECD countries, using a method based on the cointegration relation between output and the capital stock. The intuitive idea is that economic capacity (potential output) is the aspect of output that co-varies with the capital stock over the long run. We show that this notion can be derived from a simple model that allows for a changing capital-capacity ratio in response to partially exogenous, partially embodied, technical change. Our method provides a simple and general procedure for estimating capacity utilization. It also closely replicates a previously developed census-based measure of U.S. manufacturing capacity-utilization. Of particular interest is that our measures of capacity utilization are very different from those based on aggregate production functions, such as the ones provided by the IMF.