Thursday, January 26, 2006

Part 26 - Hyperwage Theory: Macroeconomics

Hyperwage Theory Part 26

Hyperwage Part 26

Chapter 26: Macroeconomics

The Keynesian multiplier which was actually first used by his student Richard Kahn was unfortunately explained by both Keynes and Kahn using algebraic and finite difference methods. I think Keynes did this because he was afraid to use mathematics that may confuse his fellow economists and students.

This method backfired because those who are not apprised that there is an underlying physical process involved tend to dismiss the multiplier as some of a free lunch or getting something for nothing. Even Nobel Prize economists became victims of this confusing concept.

To steer clear of this confusion, I introduced the infinite geometric progression of buying and selling, earning and spending to impress in your minds the real physical process behind the multiplier. It is the same physical process used by the banking system in creating money. The earning and spending process is as real as gravity, electricity and magnetism.

Now, I would like to remind you, the Keynesian multiplier is a process independent and separate from the so-called Keynesian economics. Yes, the multiplier is part of the Keynesian theory, but what I’m saying is this: Even if Hyperwage or Keynesian or Classical theory is involved, there is still the real physical process of earning and spending. There is still the marginal propensity to consume. Consumption is a real process, whether or not you believe in Hyperwage Theory.

Hyperwage Theory calls on Keynesian Theory for hand holding but eventually Hyperwage zooms away with its hyper salaries which will scare even the Keynesians. But as I have mentioned and explained in the past chapters these fears are unfounded.

Now, we go into macroeconomics. In the earlier chapters, I have discussed the difference between classical and Keynesian but I will further discuss this topic later.

Let’s us have the macroeconomic equation according to Keynes. Keynes focused on the demand side (as against the supply side). The classical schools says that “supply creates its own demand.” In the movie Field of Dreams, this is the principle of “if you build it, they will come.”

On the other hand, Keynes says, “demand will create its own supply,” or in other words, “if you demand it, they will build it.”

You might think that these two are equivalent. Yes, in a way, but no, in the real world they are not equivalent because the corresponding fiscal and monetary policies for each theory will not be the same.

Then comes Hyperwage. But that’s another story, the story of weaving it into the two theories.
Since I assume zero knowledge on your part, let me define some terms.

Aggregate demand
Aggregate demand is the total amount that all consumers, businesses, the government and foreign entities plan to spend on all final goods and services of the country’s economy. Note the four components of consumer spending, business spending, government spending, and foreign spending.

Consumption Expenditure
Of the four components of aggregate demand, consumption expenditure (C) is the biggest. It is about 60% of total expenditure. Note that Keynes has emphasized over and over again, that consumption expenditure is the most important of all the components.

Usually, macroeconomic analysis starts with a discussion of this particular component. This category of expenditure includes private or household or consumer spending on
1. durable goods (automobiles, appliances, etc.)
2. non-durable goods (food, clothing, magazines, etc), and
3. services (rentals, medical, transportation, education, amusement, etc.).
Of the three components of C, what needs special focus? We should focus on the third one, the service component. Why?

First, services represent the largest component representing, typically 50 percent of C in an economy.

Second, services include housing services which are measured directly by rents being paid from tenant to landlord in the case of rental housing. Or indirectly as imputed rent that an individual would pay to himself in the case of owner occupied housing. There is no money exchange here but it is included in the computation. Ask the economists, not me.

Third, services cannot be inventoried. How can you store consultant’s time or airline seats? Any change in the services aspect of the economy will have to be matched by changes in the other categories to maintain equilibrium. And this is not easy.

Consumption expenditure decisions are strongly influenced by household disposable (after-tax) income, household wealth, savings needs and plans, confidence in the future direction of the economy, and interest rates (in the case of durable-goods purchases).

Investment Expenditure
Investment expenditure (I) by businesses is a smaller but volatile portion of the aggregate demand in the economy.

This category of expenditure includes fixed nonresidential investment (factories, machines, transport equipment), fixed residential investment (new houses and apartments), and business inventories. Often the volatility in investment results from fluctuation in inventory levels due to changing expectation about business conditions.

Fixed residential and nonresidential investment refers to the creation of income-producing assets. Demand for the production of the asset will directly affect the revenue generated. Strong demand based on preferences, optimism, purchasing power, or demographics will lead to the desire for more investment expenditure.

Government Expenditure
Government expenditure (G) by the government is very important because it can change the economic situation in a large way. It can be used for fiscal or economic purposes, or for political purposes, or for legal regulation purposes.

Note that Keynesian economics surged after Keynes book was published because the governments loved this theory of government intervention. And in fact, Keynesian economics support deficit spending which means that the budget need not be balanced. Which government does not find comfort in an economics that assures them that there is no need to balance the budget? Again, Keynesian economics is not a carte blanche justification for government intervention in the markets. Intervention is desirable only in especial cases, not as a general rule.

Net Export Expenditure
Finally, Net export expenditure (=export-import, or X-M) is the export minus the import expenditures of an economy.

Formula for demand
Therefore aggregate demand is = (consumption by consumers) + (investment by businesses) + (government expenditures) + (export -import) or,
AD = C + I + G + (X-M)

Note, that this is the formula for aggregate demand and not income.

Now, let us take a simple conceptual step. The Gross Domestic Product (GDP) of an economy is defined as the sum of all the final goods and services of an economy.

What if the final goods and services produced in the economy (GDP, symbolized by Y) is also equal to the total final goods and services demanded (AD) by the same?

If the demand is equal to they supply, then we have an equilibrium GDP = AD, or:
Y = C + I + G + (X-M) (equilibrium equation)
Y = total income or GNI or GNP
C = household or private spending/consumption
I = investment by businesses
G = government spending/expenditure
X = exports
M = imports
(note that GNI or GNP is GDP+ net exports)

If you have to know only one equation in macroeconomics this is it. But remember this equation is an equilibrium condition (where the aggregate demand is the same as the total goods and services supplied).

Warning: Don’t ever make the mistake that GNP is equal to C + I + G + (X-M). No, sir, it’s not that way.

That equation is valid only when we assume that demand=supply or, in the words of the economists, there is a “general equilibrium.” Also, don’t ever make the mistake in assuming that microeconomic or partial equilibrium is the same as a macroeconomic equilibrium.

We have seen the determinants of the income of the economy under the assumption of general equilibrium. We can see a few things:
1. The economy grows bigger if there is more consumer spending (and yet, there is the additional effect of the multiplier which is not even seen in the equation above.)
2. The economy grows if the businessmen spend for expansion (investment) and yet, we have not discussed the accelerator effect yet.
3. The economy grows if the government spends more (and even if it in a deficit-spending mode)
4. The economy grows with more exports.

If you are in charge of the economic policy of the nation, what would you do? More government expenditure? More exports? More business expansion? More spending?

Look at the equation. Zoom in on the 60% of the component (consumer expenditure), then zoom in on the purchasing power of the consumers. How do you encourage them to spend? By giving higher wages, or by lowering price of goods?

If you think about it long enough, and if you read this series beginning Part 1, you will realize that the hope of any Third World economy realistically rests on the seemingly unrealistic Hyperwage Theory.

Thus, Hyperwage Theory weaves itself into Classical economics and Keynesian economics and yet it could be independent of the two. Why? Hyperwage Theory relies on real physical processes that are immutable. It does not rest of some flimsy idea or principle but on physical processes as real as gravity and electromagnetism.

Is asymptotic hyperinflation based on a real physical process? Yes.

Is the income multiplier based on a real physical process? Yes?

Is hyperwage productivity and creativity based on a real physical process? Yes?

Is reverse brain drain a real physical process? Yes?

In other words, Hyperwage is merely an integration of physical processes under the principle that price modifies behavior. Give labor its true value, and everybody in the economy will be benefited.
(Thads Bentulan, Nov. 3, 2005)
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