Technological Progress in a Below Full Employment Economy

September 16th, 2016
in history, macroeconomics

by Philip Pilkington

Article of the Week from Fixing the Economists

I recently came across a rather interesting argument that the famous Post-Keynesian economist Abba Lerner made in relation to his well-known doctrine of Functional Finance. Basically Lerner said that labour-saving technological innovation in a below full employment economy was not particularly socially useful.

Follow up:

In a 2003 paper entitled Functional Finance and Unemployment: Lessons From Lerner For Today in the book Reinventing Functional Finance Matt Forstater laid out this argument. First he quotes Lerner himself to the following effect,

When there is unemployment… it is not important or even useful to use less resources in any task… There is no point, for instance, in managing to carry out some task with less labor if there are unemployed workers available, because the workers set free would not be utilized for other tasks any more than the workers who are already unemployed. They would merely be added to the unemployed. Where there is unemployment, an increase in efficiency in any particular productive process does not result in any increase in efficiency in the economy as a whole. (p.163)

Forstater goes on to lay out one argument against this consideration and lays out Lerner’s objection,

Lerner does consider the possibility that, rather than producing the same amount of output with fewer workers, society could produce more output while maintaining the same amount of workers. Yet as he rightly points out, though increased saving results from increased income accompanying higher output levels — absent an exactly offsetting higher level of investment or government expenditure — the new higher level of output will not be sustainable, as all production will not be sold, and firms will cut back that production and lay off workers. (ibid)

Basically then, the higher level of output produced by the workers will not be purchased because the workers will have the same amount of income outstanding as they did before. And since we can assume that prices will not adjust, the adjustment must be made on the quantity side — i.e. by an increase in unemployment.

This is related to what is called the Domar Problem and which Randy Wray highlighted recently when he wrote,

When we turn to the subject of economic growth, it is not legitimate to ignore capacity effects as investment proceeds. Not only does investment add to aggregate demand, but it also increases potential aggregate supply by adding plant and equipment that increase capacity. To be more precise, a portion of gross investment is used to replace capital that is taken out of service (either because it has physically deteriorated, or because of technological obsolescence), while “net investment” adds to productive capacity. Further, note that while it takes an increase of investment to raise aggregate demand (through the multiplier), a constant level of net investment will continually increase potential aggregate supply. The “Domar problem” results because there is no guarantee that the additional demand created by an increase of investment will absorb the additional capacity created by net investment. Indeed, if net investment is constant, and if this adds to capacity at a constant rate, it is extremely unlikely that aggregate demand will grow fast enough to keep capital fully utilized. This refutes Say’s Law, since the enhanced ability to supply output would not be met by sufficient demand. As such, “more investment” would not be a reliable solution to a situation in which demand were already insufficient to allow full utilization of existing capacity.

When thinking in terms of technological progress it is by no means clear that an increase in aggregate supply by way of investment in new labour-saving, highly productive technologies will result in sufficient incomes for workers to then purchase the new goods and services.

There is, however, one aspect that Lerner did not consider in his example: namely, that an increase in productivity will lead to lower unit labour costs and increase exports as they become more competitive. It is indeed true that this might happen but in this case the economy that puts the new labour-saving technology in place will merely be exporting their unemployment abroad. This would then result in a classic ‘race to the bottom’ that would ultimately result in higher unemployment everywhere.

Mainstream economists avoid these problems by assuming that prices will adjust downwards at some point. Yes, in the short-run such considerations may be important but in the long-run the increases in productivity will lead to lower prices on output which can then be bought at the new higher real income levels. There is probably some truth to this as technological goods do have a tendency to fall in price, but to believe that this will occur automatically is, quite frankly, utopian in the extreme.

To understand this consider, for example, the television. Are televisions today cheaper than they were 20 years ago? Yes and no. They are probably cheaper in the sense that we get a much better television for a similar amount of money as we got a far inferior television 20 years ago, but their real money price is probably somewhat the same. If it were the case that there is higher capacity to produce the better quality televisions relative to the lower quality ones of 20 years ago then there is no price adjustment process that would ensure adequate demand all is being equal.

At the very least, such adjustments will be enormously complex and it requires heroically unrealistic assumptions about market adjustments to believe that such adjustments will cancel each other out perfectly. It is far more likely that increased capacity not met by gains in real wages will lead to depressed demand and unemployment.

With that in mind I leave the reader with a particularly colourful quote from Lerner on the problem,

Economizing resources by the use of more efficient methods is like pouring water into a broken vessel with a large hole in it that is already holding as much as it can hold. No matter how much more is poured into it there will remain no more than at the beginning. The savings due to greater technical efficiency merely go to waste in further unemployment just as any additional water merely goes to waste through the hold. (ibid).

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