SUPERINTENDENCIA DE ECONOMÍA POPULAR Y SOLIDARIA

I regret to say that I have little direct experience with economic equilibrium. Indeed, so far as I am aware, none at all. I sometimes see suggestions that we shall be moving toward equi- librium next year or perhaps the year after, but somehow this equilibrium remains firmly in the offing. (IMF Essay on “The Pursuit of Equilibrium,” Euromoney, October 1979, Sir Gordon Richardson, Governor of the Bank of England, cited in Davies 2002, 659)

1. Equilibration as a turbulent process versus equilibrium

as an achieved state

It is important to distinguish between the conventional notion of equilibrium as an achieved state and the classical notion of equilibrium as a gravitational process. The conventional notion assumes that a variable somehow arrives at, and stays at, some balance point. Time and turbulence fall out of the picture, and the focus shifts to equi- librium states and steady paths. This is by far the most prevalent notion of equilibrium in both orthodox and heterodox economics (Blanchard 2000, 46–51). The classical notion of equilibrium is quite different. Average balance is thought to be achieved only through recurrent and offsetting imbalances. Exact balance is a transient phenomenon because any given variable constantly overshoots and undershoots its gravitational center. The equilibrating process is therefore inherently cyclical and turbulent, subject to “self-repeating fluctuations” of varying amplitudes and duration (van Duijn 1983, 4–5).23Figures 3.12 and 3.13 illustrate the two competing notions.

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 Time x x*

Figure 3.12Equilibrium as an Achieved State (Stable Monotonic Adjustment)

23 _{Note that in the classical case, we are concerned with fluctuations around equilibrium, that is, with} disequilibrium paths. This is different from the standard notion of a business cycle as a fluctuating equilibrium path (Kalecki 1968, ch. 13).

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 Time x* x

Figure 3.13Equilibration as Turbulent Gravitation (Stable Monotonic Adjustment with Noise)

2. Statics, dynamics, and growth cycles

One simple way to make the transition from statics to dynamics is to recognize that the variable (x) pictured in the preceding charts may itself be the ratio of two other variables, or alternately, a growth rate. For instance, the simple Keynesian multiplier implies that short-run equilibrium output Y∗_t = It/s, where It = fixed investment and s = an exogenously given savings rate. If we interpret our generic variable as the share of investment in actual output (xt= It/Y) and x∗as the share of investment in equilibrium output (x∗= It/Y∗_t), then, since actual output is generally different from equilibrium output, each of our previous charts represents one possible path of the ac- tual investment share around the Keynesian short-run equilibrium share. Then even a stationary path for investment share could translate into corresponding growth paths for actual and equilibrium outputs. An alternate starting point would be to interpret x∗as the equilibrium growth rate of (say) output, and xtas its actual growth rate. In either case, we end up with turbulent growth as in figures 3.13 and 3.14. These issues are addressed in considerably more detail in chapter 13.

3. Differences in the temporal dimensions of key economic variables

Once it is understood that equilibrium is a turbulent gravitational process, we are in- evitably led to ask how long it might take. To disregard such considerations is to invite serious practical errors. Consider the fundamental competitive process of profit rate equalization previously depicted in figures 2.12 and 2.13. Table 3.2 provides rough estimates of the average length of time it takes each industry’s incremental rate of profit to cycle around that of US manufacturing as a whole. One would expect the cycle lengths to vary considerably across industries. Indeed, individual cycles range between two and seven years. Yet the durations of average cycles in each industry are

0 200 400 600 800 1000 1200 1400 1600 1800 2000 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 Time Y * Y

Figure 3.14Equilibrium as Turbulent Growth (Stable Monotonic Adjustment around a Growth Path, with Shocks)

Table 3.2 Durations of Incremental Profit Rate Equalization Cycles, US Manufacturing,

1960–1989

USAFOD USATEX USAWOD USAPAP USACHE USAMNM USABMI USAMEQ USAMOT

4.8 4.1 4.7 5.2 4.3 5.0 5.2 4.5 4.4

Note: Average duration of industry cycles around the incremental profit rate of total US manufacturing. very similar, all essentially in the narrow range of four to five years—even though the timing varies from industry to industry. This is an interesting finding, given that profit rate equalization is typically viewed an as a “long-run” phenomenon (Mueller 1986, 12–13). Chapter 7 takes up this and other related issues.

The equalization of profit rates is driven by the reaction of industrial investment to profitability. The higher the profit rate, the greater is the incentive for firms to ac- celerate the expansion of output and capacity. Output expansion requires circulating investment (i.e., additional raw materials, work in process, and labor), while capacity expansion requires fixed investment. Industries with higher profit rates will experi- ence growth acceleration until their output begins to grow faster than their demand, at which point their prices and profit rates will begin to decline. The opposite holds for industries with lower profit rates. Two things follow from this. Individual industry profit rates on new investment will fluctuate around the corresponding overall average rate. This is the equalization of profit rates.24But as the average profit rate on new in- vestment itself fluctuates, so too will the overall growth rates of output and investment in the economy as a whole.

24 _{If technical conditions were unchanging, the turbulent equalization of profit rates would also lead} to the turbulent equalization of growth rates. But technology is constantly changing, so that even normal growth rates will differ across industries.

Business cycle studies have identified two main types of recurrent aggregate fluc- tuations, each tied to investment in a particular type of fixed capital25: (1) inventory cycles on the order of three to five years; and (2) equipment cycles of about seven to eleven years. It is interesting to note that we now use the term “business cycle” to refer to the three to five years inventory cycle, whereas in the nineteenth and early twentieth centuries the same term referred to the seven to eleven year (“decennial”) equipment cycle (van Duijn 1983, 7–8).26Finally, there is the possibility of long waves thought to be on the order of forty-five to sixty years (van Duijn 1983, ch. 1; Su 1996, ch. 7). These were previously depicted in figure 2.10 and are further addressed in chapter 5, figures 5.5–5.6 and in chapter 16, figure 16.1.

Inventory and equipment cycles are intrinsically linked to two fundamental ec- onomic ratios: inventories are linked to the balance between demand and supply, while capital equipment is linked to the balance between capacity and actual output. Because production takes time, firms must initiate production well in advance of es- timated sales. To maintain the continuity of production, they must hold inventories of raw materials and work in progress, and to mediate the risky transition from com- pleted production to market sales, they must hold inventories of finished goods. In a growing system, there will be a desired (normal) inventory–sales ratio for each type of inventory. If actual sales happen to match those estimated at the time when produc- tion was initiated, actual inventory–sales ratios would equal the corresponding normal ratios. But this is an exceptional circumstance because, in general, actual and expected sales will diverge, as will actual and normal inventory–sales ratios. This is most evi- dent in inventories of final goods, because sales in excess of current production deplete stocks of final goods while sales below current production cause inventories to pile up (van Duijn 1983, 8–9). The utilization of inventories is therefore a proxy for excess supply. Given that the inventory cycle is on the order of three to five years, one could view this as the time it normally takes for aggregate demand and supply to balance, that is, as the temporal dimension for the “short run.”

In a Walrasian world, all markets are assumed to “continuously clear,” so that the short run is very short indeed. Keynes himself is usually concerned with comparative statics, so time disappears from view. But elsewhere he does recognize that produc- tion, and hence the working out of the multiplier, takes time. In his exposition, he tends to switch back and forth between a given observational time period which is short enough to investigate the workings of the multiplier and a period long enough for the multiplier to work itself out and hence for short-run equilibrium to obtain (Asimakopulos 1991, 52, 67–68). Modern macroeconomic analysis skips over these issues by simply assuming that supply and demand equilibrate fast enough to allow

25 _{Cycles have traditionally been identified through movements in the levels of aggregate activi-} ties. Thus, in official National Bureau of Economic Research methodology, a contraction is defined as a sustained fall in real output. A superior methodology is to identify growth cycles (i.e., fluctu- ations around a growth trend). The two can give rise to different business cycle chronologies (van Duijn 1983 , 9–11). These matters are important for macroeconomic modeling, since economic fore- casting involves “the projection of the movements of business cycles” (Su 1996, 1). Various methods of cycle-trend decomposition are discussed in Zarnowitz (1985) and Harvey and Jaeger (1993). 26 _{van Duijn (1983, 15) notes that Kuznet’s finding of a building cycle of fifteen to twenty-five years} does not survive subsequent investigations.

us to treat observed data (usually quarterly data in macroeconomics) as represent- ing equilibrium outcomes (Pugno 1998, 155; Godley and Lavoie 2007, 65). But if the “short run” was twelve to fifteen quarters instead, macroeconomic models and empirical procedures would have to be substantially altered.27

In a similar vein, production capacity28_{is linked to the stock of fixed capital, so that} the output–capital ratio is a proxy for the output–capacity ratio29(i.e., for the rate of capacity utilization). From this point of view, the seven to eleven year equipment cycle may represent the time it takes for actual capacity utilization to cycle around the normal level. This would define the temporal dimension of the “long run,” which it has to be said, is long enough to have regrets but not long enough to be dead.

This brings us to the adjustment speeds of other markets. Since financial assets can be readily created and their prices are flexible, it seems plausible that financial markets change more rapidly than commodity markets (Gandolfo 1997, 533). At the same time, they are more prone to bubbles, so it is not at all clear that they equilibrate more rapidly. Labor markets are particularly complicated because of the special nature of labor power as a commodity. Except for some types of slavery, humans are not gener- ally created in response to labor demand, so that the global supply of potential labor hours is not demand determined. Nonetheless, the local effective supply of labor hours can be augmented by inducing workers to change from the inactive to the active labor force, to change their geographical location (emigration), and/or to change the length and intensity of their working day (overtime or speed-up). So the effective supply of labor is flexible within wide limits.30This is where another aspect of the special na- ture of labor power comes into play. While the relative prices of other commodities

27 _{It has been pointed out that the mutual adjustment between aggregate demand and aggregate} supply is, from Walras’s Law, equivalent to that between money supply and money demand. One estimate of the latter adjustment yields a 50% adjustment in two quarters, so that it takes about twelve quarters to achieve 99% adjustment (McCulloch 1982, 27).

28 _{It is important to distinguish between engineering capacity which is the maximum sustained pro-} duction possible from a given plant and equipment over some interval, and “economic capacity” which is the most profitable (hence, desired) level of output (Foss 1963, 25; Kurz 1986, 37–38, 43– 44; Shapiro 1989, 184). For instance, it may be physically feasible to operate a plant for 20 hours per day 6 days a week, for a total of 120 hours per week of engineering capacity. But it may turn out that the potentially higher costs of second and third shifts make it most profitable to operate only a single 8-hour shift per day for 5 days a week (i.e., 40 hours per week). Then economic capacity, the firm’s benchmark level of output, would represent a 33.3% rate of utilization of engineering. Economic capacity in turn is also different from “full employment output.” Even though standard economic theory typically assumes that full capacity and full employment occur simultaneously, in actual prac- tice, there is no reason to suppose that production at economic capacity would serve to fully employ the existing labor force (Garegnani 1979).

29 _{Technical change can alter the capital–capacity ratio, so that the capital–output ratio is the ratio} of the capital–capacity ratio and the rate of capacity utilization (output–capacity ratio).

30 _{The classical and Keynesian vision of the labor market implicitly assumes that the supply of labor} hours is dominated by the supply of workers (i.e., that almost all available workers desire to work a normal working day). Neoclassical theory assumes the direct opposite: the supply of labor hours is entirely dominated by an infinitely flexible preference for hours worked. In the classical and Keynes- ian case, if an excess supply of labor hours leads to a decline in the real wage, this is only partially met

Table 3.3 Proposed Typology of Adjustment Speeds

Short Run (Three to Five Years) Commodity markets, inventory cycle, profit rate equalization

Long Run (Seven to Eleven Years) Capacity utilization, equipment cycle, labor market are essentially market-determined, the real wage also has social and historical deter- minants: the relative price of labor power is responsive to labor market conditions but only partially determined by them (chapter 14). We will see that the dual nature of labor power of being in-but-not-of the labor market is also what accounts for the per- sistence of unemployment. Hence, the labor market is likely to be the slowest of all the aggregate markets.

All of this points to the need to go beyond the standard distinction between the short and long run. Table 3.3 proposes one possible expanded set. This typology pre- serves the short run as the period over which aggregate demand and supply equilibrate (Keynes and Harrod) and the long run as the domain of capacity and labor market adjustment (Harrod). But the actual time intervals proposed are very different from those implicit in the literature.31_{For instance, Blanchard (2000, 19, 30–31) refers to} the period over which demand and supply equilibrate as the short run, which in his case is less than a year. His medium run, which represents a decade or two, is the period over which output is determined by supply factors such as the capital stock, technology, and labor force. And his long run of a half century or more is the period over which the education system, the savings rate, and the quality of the government determine a nation’s rate of growth.