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Chapter 7 The theoretical foundations of the growth policy

part I

Outline:

01st Growth theory, a sufficient foundation?

02nd The main determinants of growth

03rd The importance of natural resources

04th The quantitative increase of the quantity of labour

05th The improvement of the quality of labour

06th Intensive growth and labour input

07th Capital and post-Keynesian growth theory

08th Capital and neoclassical growth theory

09th Savings promotion versus investment promotion

10th Economic growth and capital structure

11th The role of technical progress

12th Stagnation on account of a too low demand?

01st Growth theory, a sufficient foundation?

The traditional growth theory is limited to the question under which conditions a balanced growth can be expected. A balanced growth presupposes here that both demand and supply of goods have the same growth rate, so that at least if we assume a balance of supply and demand in the first period of consideration, no imbalances are to be expected in the following periods.

Although this condition may be indispensable to enable lasting trouble-free growth; a growth theory can only fulfil its tasks if the question is answered, on which determinants it depends, whether, and possibly how high, the growth rate turns out. Thus, we shall find out what are the causes for the changes in the growth rate.

02nd The main determinants of growth

Starting point of our following analysis shall be the framework data of Walter Eucken. According to this, the economic activity and thus also the economic growth depends on a total of 6 data: which include:

• the natural resources including the land,

• the labour force,

• the capital,

• the technical knowledge,

• the requirements structure and

• the legal and institutional order.

It is now the production function which indicates the connections between input and output. The output, thus the production volume (X), depends on the use of all production factors, hence the number of employees or working hours (A), furthermore on the used amount of natural resources (B), including the properties required for production, as well as on the amount of capital (K) required for production. The formula applies:

X = f (A, B, K)

• X: produced quantity of goods

• A: labour input

• B: use of natural resources

• K: use of capital

At times the material production factors land and capital are aggregated, so that then the product quantity can be understood as a function of labour and capital in a broader sense:

X = f (A, K)

The role of technical progress indicates the struc-tural parameters of the production function. It de-pends on the technology applied in each case, how many units of goods can be produced with a given portfolio of labour and capital, respectively how much labour and capital is needed to produce a certain amount of goods.

In the production theory we generally assume very specific qualities of a production function, as de-scribed by Cobb and Douglas in the scope of empirical investigations. Accordingly, the production functions have the following structure:

The general growth parameter indicates which productivity features help to improve all factors, while the alpha parameter relates only to the labour factor and indicates by what percentage the examined good increases when the factor labour increases by a percentage.

It is one of the peculiarities of this Cobb-Douglas production function that the potencies of labour and capital always add up to one. In material terms, this structure means that by an increase of one of the two production factors, the yield growth decreases with increasing production of goods, whereas if both production factors are increased to the same extent, the increase in yield growth remains constant, that is the marginal level product equals to one.

Now we generally distinguish between a neutral, a labour-saving and a capital-saving technical pro-gress. The neutral progress is characterised by the fact that productivity gains are allocated to both (all) production factors, while at a labour-saving (capital-saving) progress the same production quantity as before requires less labour (less capital).

The classics of economic theory assumed a some-what different production function. While at the assumption of a Cobb-Douglas production function the law of decreasing marginal returns applies to all work assignments, it is assumed in the classical production function that initially the marginal return even increases with increasing factor input and the marginal return decreases only after exceeding a critical production level. The classical production function is backed by the notion that at given technology there is a very particular factor input ratio at which an optimum can be achieved, while any deviation from this optimal input ratio (both an increase and a decrease) leads to a suboptimal production.

Demand also determines growth. Initially, the production function shows only which quantity of goods could be produced. In a market economy, however, only the types of goods and quantities of goods are produced, for which there is a need indicated by demand. Goods that are not in demand are not even produced. In this respect, the actually realised growth rate of the domestic product always depends on the growth rate of demand. For growth to come about, both the possibilities for production as well as the development of demand are necessary preconditions.

Whether and to what extent economic growth is possible depends ultimately also on the in each case realised institutional order. An economic order determines which values are to be realised. From the catalogue of the values to be preserved, it can then be deduced which courses of action are necessary to preserve these values and which other actions endanger these values. An order also consists always of the incentives to bring about the required behaviour, whether it be the punishment that prevents the economic agents from nevertheless committing the prohibited actions or be it that the desired actions are rewarded.

03rd The importance of natural resources

In ancient times, raw materials and natural transport routes were the most important basis for economic growth.

With industrialisation, the importance of natural resources for growth declined. Natural raw materials can be replaced by artificial ones. The fertility of the soil can be improved by manuring. Artificial transport infrastructure can be built.

Nowadays, nature has a greater role to play again: in the first place, we have the problem of environmental pollution: industrial production causes environmental damages, due to which the number and severity of natural disasters is increasing.

Thereby, the problem of scarce raw materials is addressed, too: Due to the scarcity of raw materials, arose the demand for sustainability; to leave sufficient resources of raw materials for subsequent generations. This occurs partly by recycling, partly by developing new resources such as e.g. the alternative energy from solar and wind power or the biomass.

04th The quantitative increase of the quantity of labour

Now, let us ask to what extent the production factor labour (A) influences the output (X), the domestic product. Here, it must be differentiated between a purely quantitative and a qualitative relationship. This differentiation applies equally to both input and output. In principle, we must assume that an improvement in the quality of the labour force leads to an increase in quality in the product as well.

But it is also conceivable that a mere increase in labour units leads to improved quality of the products. Suppose that because new labour force is hired in production, and therefore each individual employee is responsible for fewer products, just therefore he can draw his attention to the remaining quantities of goods, so that less waste is produced, and the remaining goods show fewer defects and in this way the quality of the goods is increased.

Similarly, however, can the quantity of the products be increased also conversely by an improved quality of labour. Accordingly, it is conceivable that due to a new process the quality of the goods to be produced can be improved significantly, but that at this process new machines must be purchased, which require special training of the qualified labourers. However, the increased production in this case is actually rather to be attributed to the changed technology, which in turn presupposes an improved quality of labour.

We begin the analysis by trying to increase or also improve the quality of production by increasing the use of the factor labour.

Numerous determinants influence the labour input. The number of available working hours is determined:

• by the birth and death rate; more children are born or fewer workers die before they leave the labour market. Here, it shall be considered, however, that the children born today enter the labour market only after about 20 years, so that for this reason the number of employees increases strongly delayed.

• by the net immigration (the difference between immigration and emigration); in overall terms, more people are available in an economy if more young and employable people immigrate than emigrate at the same time.

• by the age of entry and retirement; here, the number of labour force is increased thereby that workers either enter the labour market sooner or retire later as hitherto from the labour market. However, it must be considered here that in the reality the reverse processes take place mostly, that due to the extension of the training period, the entry into working life takes place only at a higher age or retirement age occurs earlier.

• by the change in the employee rate of the labour force; furthermore, the number of workers can also be changed thereby that previously self-employed persons lose their self-employment, in this case the number of employees increases, or else that people who were previously considered as employees, are active as self-employed now. Of course, the number of employees can also be changed thereby that employees give up their working life at all, thus e.g. become homeless or cannot be gainfully employed due to health reasons.

• by the extent of unemployment; if employees are willing to work but cannot find employment, then the total number of available working hours is less than it could be without unemployment. In this respect, a successful reduction of unemployment can help to increase the number of available labour force.

• by the increase or decrease of part-time employ-ees; while the changes in the factor labour listed above have changed the number of labour force, can the amount of labour input also be changed by changing the average number of hours worked. We must always expect that some of the employees do not work full-time. Now, as the proportion of part-time workers changes, this change also affects the average work time per employee. The same applies if employees must work short time due to a decline in the demand for goods.

• by a possible increase in the effective working time; but the same effect can be expected even if the effective working time changes, for example, if the contractually provided working hours in the collective agreements are shortened. However, it must be reckoned with the possibility that effective working time may remain unaffected by these changes in the collective agreements, if employees increase their above the scale working time in form of overtime working hours by the same amount. Of course, an increase or even a reduction in overtime hours can vary in the scope of effective working hours, naturally also regardless of tariff changes.

• by the reduction of the sickness rate and the accident frequency; illness and accident can lead to a temporary incapacity for work and thus reduce the number of available working hours. In the event of accidents, the ability to work may be sometimes limited permanently. Advances in medicine can eventually lead to an increase in the available working hours again.

05th The improvement of the quality of labour

Let us now turn to the possibilities to improve the output by raising the quality of labour. The quality of labour can be increased primarily by two sets of measures:

On the one hand, by education policy: By allowing a larger part of young people the access to secondary schools and universities, the labour productivity can be increased. Sometimes occurs unemployment to unemployed workers simply because technological advances can lead to production facilities that require an ever higher educational level from the labour force. By qualification of the previously unskilled workers can be prevented in this way that these become unemployed due to technical progress.

On the other hand, by mobility policies: The in-crease in mobility means that workers can increasingly be deployed where they achieve the highest productivity. It can often be assumed that individual employees have not yet found the workplace that matches their abilities at their first job. If there were no possibilities to a job change for the individual employees, their labour productivity would be suboptimal permanently. By changing jobs, it can be achieved that labour productivity increases in the long run, even if each change entails adjustment costs.

06th Intensive growth and labour input

In our previous considerations, we had dealt with the extensive growth. We started from a production function and asked for the determinants why the output could be changed for the better due to an increased or also improved employment of labour. But as we have already pointed out, the economic growth is seen first and foremost as a benchmark of macroeconomic welfare.

However, the welfare of a population depends less on extensive than on intensive growth. A population does not become richer automatically when the domestic product increases due to more available workers. The domestic product has risen here, but so has the number of people to whom this product must be divided. The individual citizens achieve a welfare gain only if either the per capita income or the labour productivity increases. Therefore, let us turn now to the question of which relations exist between labour input and intensive growth.

To this, let us look at the individual determinants of labour input, namely firstly the population growth caused by immigration (B). The domestic product is rising (Y); it is unclear, however, whether the per capita income will increase, too.

The per capita income is calculated by the ratio of domestic product and population: Y/B. With an immigration both sizes, numerator and denominator rise. Depending on whether the domestic product increases more or less than the population, the per capita income increases or decreases. (figure 2)

Now we consider secondly the increase in the birth rate and the thereby triggered population growth. Initially, the supply of workers may decrease, as possibly more women are only working in their own household and are no longer employed in an extra-familial occupation. In this case, the per capita income even declines temporarily, since women are temporarily unemployed before and immediately after birth. The number of employees and thus also the domestic product is thus decreasing at the same population size.

But in the long term, as the children born today will become gainfully employed in the future, the number of employees and thus the domestic product will increase again.

As third reason for intensive growth may an in-crease in working hours be assumed. With a con-stant number of employees, there is an increase of the work supply calculated in hours.

But due to the law of diminishing marginal returns of labour, this leads to a reduction of labour productivity. The domestic product is rising, but it is rising less than the number of working hours. Thus, the per capita income increases, but the productivity of labour decreases at the same time.

Now - as already mentioned - we generally distinguish between two different yield functions. The classical theory was based on the following yield function: An increase in the labour input thus leads initially to an increase not only in the quantities of goods, but also in the average yield of the labour, since regarding an optimal factor combination, the labour force is initially present in a too small an extent. Now, if production continues to rise, then a critical threshold is finally reached, from which on the product quantity continues to increase with additional labour input, but the average yield decreases.

This is based on the idea that there is an optimal input ratio between capital and labour. If this optimal input ratio (A/K) is given, then the productivity has reached its maximum value. However, on both sides of this operation ratio, namely at a higher or a lower labour input, the productivity is lower and thus suboptimal.

The exact location of this threshold is of course not in the nature of the factors of production. Rather, it depends on the type of technical progress, at which input ratio this optimum is achieved. A change in technology therefore usually changes the point at which the average yield reaches its optimum.

We take an example of an enterprise that aims to change the technology in order to allow certain work steps, hitherto done by workers, to be done by machines, thereby saving labour. Thus, a new production plant is constructed, which fulfils this aim as exactly as possible and which requires a very specific capital investment. This capital investment is thus given by introducing this new method, and together with the planned factor input ratio for this new production plant the amount of labour at which this optimum is achieved is then calculated. (figure 4)

The type of technical progress is thus, primarily responsible for the development of labour productivity. We distinguish between neutral, labour-saving and capital-saving technical progress.

With neutral technical progress, savings are made in principle at all relevant production factors. At this, neutral progress is defined differently in the growth theory. Harrod speaks of neutral progress when capital productivity remains constant at constant interest rates:

K/Y = constant for i= const.

Whereas for Hicks there is a neutral progress pre-sent when the capital intensity remains constant with a constant wage-interest ratio:

K/A = constant for l / i = const.

Finally, Solow speaks of a neutral technical progress, if labour productivity remains constant with a constant wage rate:

A/Y = const. for l = const.

Furthermore, it is spoken of a labour-saving tech-nical progress, whenever the technical progress is mainly only labour saving.

Analogous to this, it is spoken of capital-saving technical progress, if the savings relate primarily to the capital investment. It can be assumed that even in this case the average product of labour can increase, just as with labour-saving progress also the average product of capital can increase.