Neglected Implications of Neoclassical Capital-Labour Substitution for Investment Theory: Another Criticism of Say's Law

Abstract

Recent mainstream macroeconomic models take Say's Law for granted. This paper argues that the justification for this assumption is not found in general equilibrium theory but in the ‘neoclassical-synthesis’ (and then monetarist) criticism of Keynes, which relies in a fundamental way on a treatment of investment that turns out to depend not only on neoclassical capital-labour substitution (called into questioned by the Cambridge controversies) but also on an assumption of full labour employment that on the contrary should be a result of the analysis. This paper first criticizes the attempt to justify a negative interest-elastic investment function through adjustment costs, that is, without relying on traditional neoclassical capital-labour substitution, with special attention on the treatment in Romer's advanced textbook. Then it proceeds to its new contribution, the demonstration that an endogenous determination of labour employment raises questions about the capacity of decreases in the real wage to raise employment even accepting neoclassical capital-labour substitution, because when the latter is correctly understood the rate of interest does not suffice to determine investment; hence, there is an inevitable role for the accelerator (and Say's Law is thereby undermined). This was perceived by Dornbusch and Fischer but they did not realize that then reductions of real wages will reduce investment instead of raising it. Thus, the ‘neoclassical synthesis’ reply to Keynes is undermined even apart from the inconsistencies of neoclassical capital theory. So the paper exposes a deficiency of the neoclassical arguments in support of a tendency toward full employment, additional to the inconsistencies revealed by the capital critique.     

Agriculture in recent development theory

This paper is a critical review of recent contributions to the literature on agriculture in development theory. It considers and compares the main lines of advance made within neoclassical, neo-Marxian and structuralist approaches. Recent neo-Marxian and structuralist studies of agrarian development reveal that traditional agriculture is neither stationary nor efficient, that resource allocation cannot be separated from wealth distribution or production organization, that forms of surplus appropriation do not necessarily follow the dictates of efficiency, that the social relations of production may inhibit accumulation and determine the forms of technological change, that the state's role in primitive accumulation is more economic than explicitly coercive/political, and that political and macroeconomic constraints preclude a simple ‘get the prices right’ view of the intersectoral terms of trade. The thrust of these developments is to challenge both neoclassical and some orthodox Marxian formulations of agrarian development issues and add to the insights to be gleaned from a political economy of development.     

The ineffectiveness of effective tax rates on business investment: A critique of Feldstein's Fisher-Schultz lecture

In his Fisher-Schultz Lecture, Martin Feldstein (1982) examined the effects of non-neutral tax rules on business investment by estimating three econometric models, and he concluded that ‘the rising rate of inflation has, because of the structure of existing U.S. tax rules, substantially discouraged investment in the past 15 years’. In a detailed examination of Feldstein's Effective Tax Rate model and a less extensive review of his other formulations (neoclassical and return-over-cost), we advance a number of important and independent criticisms, and find that these three models fail to support Feldstein's conclusion that taxes have exerted a significantly depressing effect on net investment during the recent inflation episode.     

Savings and investment in Australia

It has become popular to advocate tax reduction on the basis of promoting savings, investment and ultimately economic growth. The linkage between the variables is argued by various neoclassical growth models and is further suggested by recent studies which highlight the close association between domestic saving and investment rates. The close association may allow for polices which alter domestic saving levels in order to alter domestic investment levels. This interpretation, however, presumes an endogenous investment response. Equally likely, theoretically, is that the close association is maintained by movements in national savings. The present paper explicitly examines the endogeneity of the Australian saving and investment rates. The results highlight the exogeneity of investment. The results further suggest an endogenous response on the part of Australia's saving rate. The results may limit the potential benefits of these tax changes.     

DETERMINANTS OF PRIVATE INVESTMENT IN MALAYSIA: WHAT CAUSES THE POSTCRISIS SLUMPS?

This paper examines the determinants of private investment in Malaysia, with an emphasis on the postcrisis investment slumps. A static private investment function is derived from the neoclassical framework, with appropriate modifications to account for the structural features observed in the country. To introduce dynamics into the model, we adopt a cost minimization problem, which assumes firms optimize investment levels with respect to a quadratic loss function. The results suggest that the availability of financial resources in the economy has a significant positive impact on private investment. Macroeconomic uncertainty exerts a negative influence on the investment climate in the private sector. Both foreign direct investment and public investment are found to have a complementary effect on private investment. Consistent with the prediction of the neoclassical model, a higher level of aggregate output raises private investment, whereas the user cost of capital has the opposite impact. (JEL O16, O53)     

Supply-Side Economics of Germany's Year 2000 Tax Reform: A Quantitative Assessment

Abstract. The paper provides an assessment of supply‐side economics following Germany's year 2000 tax reform. Investigated are a corporate tax cut, deteriorating depreciation allowances and imputation rules, and a private income tax cut. For this purpose, a neoclassical growth model is augmented by various fiscal policy parameters and endogenous corporate finance and calibrated with German data. The model is used to evaluate consequences of Germany's tax reform on production, firm finance and leverage, investment, consumption and welfare of a representative household.     

Vanishing income redistributions: Keynesian clues about model surprises in the short run

A compact, one-sector version of recent large-scale income distribution models is presented. Different specifications of endogenous and exogenous variables in the model (or assumptions about how it is closed) change its qualitative behavior directly. A ‘Keynesian’ closure in which investment is exogenous and nominal changes in prime cost are passed along into price increases demonstrates relative insensitivity of the functional income distribution to factor prices. An alternative ‘neoclassical’ closure in which investment is endogenous (determined by savings) and output prices are fixed is much more responsive. The large-scale models are closed on Keynesian lines, and also have relatively insensitive functional distributions. If these models adequately describe real economies, causes besides general equilibrium price response must be invoked to explain distributional change.     

新常态下的人力资本与经济增长——综合金融资本和创新创业的理论建模

在国内外形势的双重影响下,中国经济步入了"新常态"的阶段,放缓的经济增长步伐带来新的矛盾和挑战,经济增长模式从以往的粗放型逐渐向集约型转变,但以往的经济理论在经济新阶段都具有一定的局限性.本文使用主流宏观经济学前沿的建模方法将现有的四大经济增长理论囊括在一个综合模型中,把人力资本投资、金融资本投资、实物资本投资、创新创业活动、纳什博弈机制有机地结合在统一的分析框架下,对经济增长理论文献做出重要的概括和拓展.通过校准赋值和数值模拟,得出理论模型的基本结论:人力资本积累虽然可以通过创新和创业促进经济增长,但是其效果仍是递减的,呈现出新古典增长模型的属性.     

Macroeconomic implications of dynamically inconsistent preferences

Despite the widespread use of models of intertemporal choices in economics, previous studies have assumed that intertemporal preferences are dynamically consistent. This paper provides a fresh perspective on propagation mechanisms of a typical macroeconomic shock in a model with dynamically inconsistent preferences. To this end, I develop a prototypical neoclassical model that features dynamically inconsistent preferences to explore dynamic responses of key macro-aggregates, discounted cumulative effects and some characteristics of aggregate fluctuations in response to a technology shock. The main findings reveal that (a) consumption and investment in the proposed model show a larger increase than those in a standard neoclassical model; (b) unlike the standard model, the proposed model yields a short-run decline in labor, which is corroborated by previous studies; (c) all of these dynamic responses in the proposed model deliver smaller cumulative output effects; (d) the proposed model does a reasonably good job of matching key characteristics of aggregate fluctuations with the counterparts observed in the postwar U.S. data. The present-bias and sophistication effects are the linchpin of these main results. Various analyses on a set of different parameter values are also discussed.     

OVERLAPPING GENERATIONS MODEL,INVESTMENT FUNCTION AND DYNAMIC EFFICIENCY OF RESOURCE ALLOCATION*

This paper suggests that the possibility of dynamically inefficient resource allocation as pointed out by Diamond (1965) is due to the neoclassical property of that model where no investment instalment cost, and hence no investment function in the proper sense, may exist. If one introduces, instead, Tobin's q-theory type investment function, competitive equilibrium is shown to be consistent only with the dynamically efficient use of resources.     

Investment rates and the aggregate production function

In this paper we consider a simple version of the neoclassical growth model, and carry out an empirical analysis of the main determinants of aggregate investment across countries. The neoclassical growth model predicts that aggregate investment may be influenced by income growth, the capital income share, the relative price of capital, taxes, and other market distortions. We check these investment patterns for both OECD and non-OECD countries. We also decompose investment data into equipment and structures, and explore major factors affecting their relative prices. These empirical exercises shed light into the shape of the neoclassical production function.     

Understanding the Effects of a Shock to Government Purchases

This paper investigates the consequences of an exogenous increase in U.S. government purchases. We find that in response to such a shock, employment, output, and nonresidential investment rise, while real wages, residential investment, and consumption expenditures fall. The paper argues that a simple variant of the neoclassical growth model which distinguishes between nonresidential and residential investment is consistent with this evidence.Journal of Economic LiteratureClassification Numbers: E1, E6.     

Australian Business Investment: A New Look at the Neoclassical Approach*

This paper attempts to reconcile neoclassical theory with Australian investment data. We argue that, by focusing almost exclusively on the demand for capital services, neoclassical investment theory neglects two related decisions: the decision to own the existing capital stock, and the decision to produce new capital goods. We propose a simple model of investment behaviour that integrates production decisions with portfolio decisions. Careful consideration is given to the determination of the price of capital, the rental price of capital, and the return on capital. The model is estimated by FIML, and a number of simulation results are reported.     

MODELING AND MEASURING THE ECONOMIC ROLES OF TECHNOLOGY INFRASTRUCTURE

Designing and managing an economy's technology infrastructure requires both accurate economic models and data to drive them. Previous models treat technology as a homogeneous entity, thereby precluding assessing investment barriers affecting infrastructure elements. The model presented overcomes this deficiency by disaggregating the knowledge production function into key elements of the typical industrial technology based on the distinctly different investment incentives associated with each element. Without such a model, the economist's ability to assess important market failures associated with investment in the major technology elements, including those with infrastructure (public-good) characteristics, is compromised. Unfortunately, even with the correct knowledge production function, the required data are difficult to collect. This forces government agencies, which fund a majority of technology infrastructure research, to use second-best approaches for economic analyses. The second half of this paper therefore presents an analytical framework that can be driven by more accessible data and provide reasonable impact assessments until better data become available.     

Fiscal shocks and their consequences

This paper investigates the response of hours worked and real wages to fiscal policy shocks in the post-World-War II US. We identify these shocks with exogenous changes in military purchases and argue that they lead to a persistent increase in government purchases and tax rates on capital and labor income, and a persistent rise in aggregate hours worked as well as declines in real wages. The shocks are also associated with short lived rises in aggregate investment and small movements in private consumption. We describe and implement a methodology for assessing whether standard neoclassical models can account for the consequences of a fiscal policy shock. Simple versions of the neoclassical model can account for the qualitative effects of a fiscal shock. Once we allow for habit formation and investment adjustment costs, the model can also account reasonably well for the quantitative effects of a fiscal shock.     

IS GOVERNMENT SPENDING STIMULATIVE?

This paper develops and implements a neoclassical model of fiscal policy. The paper's main empirical hypothesis is that government non-military investment spending is more expansionary than is either government consumption or military investment. The paper utilizes annual data to support the hypothesis. It finds that output "multipliers" for government non-military investment significantly exceed unity while multipliers for government consumption and military investment lie below unity. The paper also finds that public sector deficits—both actual and cyclically adjusted—contain minor explanatory power for output when one controls for the effects of non-military investment.     

Book Reviews

This paper reformulates Kalecki's investment models based on 'the principle of increasing risk'. First, it is shown that in his model risk can be interpreted as a conditional probability of bankruptcy of a firm, or the 'hazard rate' in reliability theory. Secondly, a simple static Kaleckian investment model is developed based on this interpretation. In the model, a slightly modified Kaleckian optimality condition for investment holds. It is also shown that, as Kalecki correctly pointed out, the principle of falling marginal efficiency of capital (or investment) is not required to obtain a finite level of investment. Finally, I consider sequential investment in an intertemporal model. In this model, a modified version of the Kaleckian optimality condition determines investment. In addition, as Kalecki emphasized, his increasing risk limits the level of investment even without increasing and convex adjustment costs associated with investment, by which the finite rate of investment is derived in the macroeconomics literature.     

A contribution to the theory and empirics of Schumpeterian growth with worldwide interactions

This paper proposes an integrated theoretical and methodological framework characterized by technological interactions to explain growth processes from a Schumpeterian perspective. Global interdependence implied by international R&D spillovers needs to be taken into account in both the theoretical and empirical models. For this task, spatial econometrics is the appropriate tool. The econometric model we propose includes the neoclassical growth model as a particular case. We can therefore explicitly test the role of R&D investment in the long-run growth process against the Solow growth model. Finally, the properties of our spatial econometric specification allow the explicit evaluation of the impact of home and foreign R&D spillovers.     

A spillover‐based theory of credentialism

I propose a model in which credentials, such as diplomas, are instrumentally valuable to workers. The model avoids an important criticism of standard job market signalling models by tying a worker's wage to their output. A worker's productivity is influenced by the skills of their co‐workers, where such skills arise from an ability‐augmenting investment that is made prior to matching with co‐workers. Credentials allow workers to demonstrate their investment to the labour market, thereby allowing them to match with high‐skill co‐workers in equilibrium. Despite the positive externality associated with a worker's investment, I show how overinvestment is pervasive in equilibrium.