Saturday, August 8, 2009

By different means we arrive at the same end

James Hamilton has written a number of pieces going back 15 or 20 years (most recently here) on the importance of oil prices to recessions in the US and other rich countries. He claims that every recession in the past 30-40 years has been preceded by a spike in oil prices, and on casual observation seems to be true. Of course, this being economics, a fair amount of his energy is devoted to whether this relationship holds up econometrically, which is not all that interesting; and another fair amount is devoted to whether it would obtain in some kind of idealized rational-agent economy, which is not interesting at all. He does say plenty that is interesting, tho, including this: that the earlier shocks were a reduction of supply faced with more or less stable demand, but the more recent price accelerations were the result of rising demand and inelestic supply.

Which suggests a point of contact with a quite different literature, the cyclical profit-squeeze analysis of business cycles. This is a Marxian approach to fluctuations, which starts from the observation that almost every downturn is preceded by a decline in the profit rate and then decomposes that decline using the same kind of accounting framework that people use to talk about long-term declines in profit rates. Most typically, changes in the profit share are broken down between the profit share of output, the rate of capacity utilization, and the output-capital ratio at full utilization (i.e. the rate of potential output to capital; this isn't exactly the organic composition of capital, but it can be thought of in a somewhat similar way.) The relative importance of these components, secularly and especially cyclically, is in that order; thus this gets called the “cyclical profit squeeze” approach, since it's the rising labor share late in the expansion that evidently triggers the downturn. (In that order in the US, that is; in East Asia, and presumably other rapidly industrializing regions, there has been a steep rise in the capital-output ratio, unlike in the US where it's essentially flat over the postwar period.) Other writers decompose the profit rate differently but the basic approach is the same.

What does this have to do with oil prices? The answer is that more recent iterations of the cyclical profit-squeeze approach have found something very interesting. In the 50s, 60s, and 70s the “labor squeeze” took the straightforward form of an acceleration of real wages late in an expansion. But in recent cycles, real wages have been essentially flat over the cycle – and yet the labor share has continued to rise in expansions. How is that possible? Because late in expansions, the prices of wage goods (i.e. the CPI) rise significantly faster than the price of output (i.e. the GDP deflator.) In other words, even though workers' real incomes don't rise much in a boom, the share of output needed to provide them with those same incomes does rise, meaning less is left over for profits. In other words, in a boom an increasing share of income goes to stuff we consume, but don't produce – including imported oil, obviously, but also things like rent of land.

So these two very different approachs seem to lead to the same place, namely, a cyclical dynamic based on the increasing share of output going to factors in inelastic supply (or non-produced means of production) as growth exceeds a certain rate, or goes on for an extended period. In more recent cycles, profits are being squeezed by land rather than by labor, but maybe the underlying dynamic is the same. And if you think what chokes off growth in a boom is ultimately the claims of owners of non-produced factors, that suggests we might want to revive the classics, and think about a functional distribution between not two claimants – labor and capital – but between three – labor, capital and land. It's a question, one suspects, that will only become more pressing in the coming century as “land” in the broad sense – land itself, oil, water, and other environmental inputs – become an increasing important constraint on growth.

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