Workshop on Effective Demand, Income Distribution and Growth th EAEPE Annual Conference, Bremen, November 10-12 17
Wage and employment in a finance-led economy
The object of this paper is to analyse the links between income distribution and growth in a finance-led economy. In fact, the increased share of financial activities creates a new macroeconomic and income distribution dynamic. Dividend distributed by firms, banks behaviour, financial profitability norms… modify investment and consumption dynamic. A
growing part of income is collected by shareholders and affects the consumption function. Moreover, profitability norms fixed by shareholders in the short term may reduce investment. It results in a new macroeconomic dynamic which affects employment and wage determination.
To study links between income distribution and growth, and thus employment, in finance-led economies, we will use a post Keynesian “stock-flow” macroeconomic model.
This kind of model is developed by Godley and Lavoie (2001). These models are generally specified by a Kaleckian wages determination, by a mark-up rule in goods market. Here, we will introduce an endogenous wage determination lead by class struggle, as Goodwin (1967). We will still deal with a markup rule and take into account financial actors. The Goodwin model takes place in a classical framework, where saving affects investment and where there is no demand constraint. On the contrary in a Kaleckian or Keynesian framework, saving and investment don’t respond to the same determinants and the causal relation is reversed. So, the object of this paper is to introduce an endogenous wage determination in a Keynesian model, with a demand constraint but also with an investment financing constraint, in a finance-led economy. Moreover, there is no saving constraint in our model. But, money plays a central part and credit rationing can decrease investment. As Keynes (1937) said, a lack of liquidity can occur, but not of saving. Finance development affects banks behaviour and then credit access by modifying their liquidity preference.
1 Université Paris I Panthéon-Sorbonne, MATISSE-CNRS (UMR 8595)
106-112 Bld de l’Hôpital, 75013 Paris, Bureau 224
To consider modern finance-led economies specifications, we will introduce financial and credit markets but also speculative assets market, as Taylor (1991). We will present the model by markets in a first time. Then, we will analyse wages and employment determination in a finance-led economy, in comparison to this of Goodwin (1967) model. We will also see the relationship between income distribution and cycles in a finance-led economy, always in comparison to Goodwin model. Finally, we will use simulations experiments to analyse model reactions to a change in key parameters, and mainly a change in financial parameters. More precisely, we will see what the relationships between wages determination and economic dynamic are in a finance-led economy.
1. Model presentation
The model purpose is to introduce an endogenous wage determination, outside the goods market, as Goodwin (1967), in a post Keynesian model but also to consider finance development and credit rationing. For this, we will introduce financial profitability norms in the investment function and dividends distribution to shareholders. This last modify the consumption function. So, with dividends and interest payments, all profits are not invested. To achieve this, we will not consider the total profit share in the investment function, on contrary to Goodwin, but only anticipated profits linked to economic activity. Firms can finance their investments by issuing equities, borrowing from banks and by retained earnings.
In this model, there are five agents: workers households, shareholders, firms, banks, and an external agent (foreign countries for example). It is composed by five markets: goods market, equities market, credit and money markets and speculative assets market. Accountable matrices are presented in annexes. Exponents in variables represent the demand (d) or the supply (s) and the indexes the agents (a for shareholders, w for workers, f for firms, b for banks and e for external agents).
1.1. Goods market
sddY?C？I. It represents the The production level is determined by aggregate demand,
total income which is divided between profits and wages. This income distribution influence next period consumption and investment.
1.1.1. Consumption function
We will consider two kinds of consumers:
As Taylor (1991), we first consider wage-earning workers with a propensity to consume equal to one. The second part represents the shareholders. Their income is only constituted by dividends and interests on deposits. This is a simplification but it doesn’t really modify analysis results.
Workers households consume wages of previous period:
With . We will see in the next section how wages are set up. ：，1
Shareholders hold interests on deposits and dividends. In counterpart they consume following their propensity to consume and they save:
ddWith dividends received at the previous period, interest on deposits Dr，M(？1)(？1)ama
and； the propensity to consume.
Dividends are determined following the stock of equities hold by shareholders
dddddderhouseholds () and the equities rate of return (): and, D，r，ee，e？！eae(？1)(？1)aeaaaa
sDfsswith, dividends distributed by firms () on the stock of equities issued (). r，Deeffsef
The rate of return on deposits is exogenous, . r，rmm
1.1.2. Investment function
On contrary to Goodwin (1967), we will not consider that profitability affects investment. The profitability level is an indicator of firms’ internal financial possibilities. Yet,
firms distribute dividends and pay interest on loans. So, retained earnings represent a better indicator of firms’ income than the profits share. But, these variables don’t enter in firms’
investment decision but in firms financing capacities. So, we will make a difference between
firms’ investment decision according to economic activity and financial norms and investment financing conditions. Yet, these last can limit the investment, we will see this point with the credit market.
The demand level influences the investment. Goodwin (1967) model doesn’t take into
account the demand effect on investment, as N.Canry (2005) underlines. To analyse this effect, we will consider the rate of capacity utilisation, as most of post Keynesian models (Godley and Lavoie 2001, Taylor 1991).
In a finance-led economy anticipated returns on investment, represented by the economic activity evolution, are compared with financial profitability norms and no more with interest rates as Keynes (1936). Because of uncertainty, past and present facts play an important part in firms’ decision and tend to replace anticipated events. Keynes (1936)
developed this idea of past and present facts prevalence in investment decisions. Firms invest only if anticipated returns are equal to a certain norm. With financial activities development, this norm is now set up on financial markets. Boyer (2000) also introduces financial norms in the investment function. If the anticipated return is inferior to the financial profitability norm, firms will not invest. High financial profitability norms create increasing investment selectivity. We will see later firms behaviour in the speculative asset market when investment opportunities are weak.
We can now present the investment function:
！Y(？1)With economic activity fluctuations of previous period, financial (Y(？2)
Yu，profitability norms and the capacity utilisation ratio, with μ the productivity. We ?，K
;；K，K1？?？Iwill consider equally the capital depreciation:, with the depreciation ?tt？1t
Firms can finance their investment by retained earnings but also by issuing equities and contracting loans. We will see that the real investment can differ of the one established by the investment function.
1.2. Equities market
Equities are issued by firms. They finance by this mean a percentage x of their investment
S), regardless to the price of equities. This which is not covered by retained earnings (f(？1)
formulation is inspired by Godley and Lavoie (2001) and Kaldor (1966). A lag of time is introduced because firms set up their financing structure on previous period because of uncertainty: