Download 3 Lance Taylor Ch. 7 Devaluation, Output, and Capital Flows.

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Lance Taylor Ch. 7 Devaluation, Output, and Capital Flows.
What are the effects of devaluation and increased money wages? Does devaluation and lowering of wages increase
production? Consider an Keynesian open economy where production is dependent on imported intermediate
goods by a fixed proportion a of the total output X. The prices for imports and exports are given by the world
market and are normalized to be equal to the exchange rate e (world market price P ∗ = 1). Although the
economy is open ,the domestic prices are allowed to vary because most goods are non-traded. Prices are set as
a mark-up on variable costs due to monopolistic competition. (this assumption goes back to Kalecki)
P =
W b + ea
⇐⇒ P = πP + W b + ea
1−π
(1)
e = exchange rate, b = L/X =labour/output ratio, X =total output, P =nominal price level, W =nominal
wage, π =profit share (a measure of monopoly power), a =import/output ratio.
We define the variable φ as
ea
a
(2)
φ=
=
W b + ea
a+ W
e b
φ = the share of import costs in variable costs.
It follows that the real wage, w is
W
(1 − π)(1 − φ)
=
( ⇐⇒ wb = (1 − π)(1 − φ))
(3)
P
b
Hence, the wage earners share of output, wb, is equal to the wage share of variable cost (1−φ) times the variable
cost share (1 − π). Two definitions:
X
u=
(4)
K
r = πu
(5)
w=
u =output/capital ratio (capacity utilization), K =total capital stock r = profit rate (profit/capital i.e. rate of
return)
Exports E is a function of the real exchange rate q
(
q=
e
=
P
e
W b+ea
1−π
=
E
=)ε = ε(q)
K
(1 − π)φ
( ⇐⇒ qa = (1 − π)φ)
a
(6)
(7)
ε = export/capital, q = real exchange rate
Investment demand is a function of profit rate and output
I D = g0 K + αrK + βX
⇓
i
g = g0 + (απ + β)u
(8)
g0 < 0 is depreciation, α > 0 represents the positive impact from the profit rate. β > 0 is an accelerator.
D
g i = IK is capital growth rate given by the investment demand.
Savings (investment supply) is a sum of wage earners savings, Sw ,profit earners savings Sπ and inflow of
funds, foreigners savings SF . Note that
SF = aXq − E
(9)
Total savings is
S = Sπ + Sw + SF = sπ πX + sw (1 − π)(1 − φ)X + φ(1 − π)X − E
g s = {sπ π + [sw (1 − φ) + φ] (1 − π)} u − ε
(10)
sπ =savings rate for capitalists, sw =savings rate for workers. Assume sπ > sw . Note that we include exports
ε here. The equilibrium condition is
gs = gi
(11)
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10 endogenous: P, u, X, r, w, g i , g s , φ, ε, q. We see that u is endogenous that implies one of the structuralist
features. The model has the Keynesian possibility of under utilization of capacity i.e. u has a maximum but
no minimum. P is endogenous. Production is demand determined. Hence g s is must be steeper with respect
to u than g i in order for the model to have meaningful solution
{sπ π + [sw (1 − φ) + φ] (1 − π)} > (απ + β)
3.1
(12)
Devaluation or reduced wage
What happens in this economy if there is a devaluation e ↑ or an increase in the nominal wages W ↑? First go
to equation (2) and see that
∂φ
> 0 and
∂e
∂φ e
∂φ
=−
∂e φ
∂W
∂φ
<0
∂W
W
φ
the devaluation and the increased nominal wage have opposite effect on the imports share in the variable costs.
• Devaluation and real wage reductions are alternative and have the same effects.
• The real wage is a decreasing function of φ.
When the wage increases imports gets relatively less important, but when there is a devaluation the imports
get more important. This will not affect the investment demand function. The question is whether g s shifts up
or down. Differentiating (10) with respect φ gives
∂g s
1−π
= (1 − sw ) (1 − π)u − ε0
∂φ
a
Assume that the Marshall-Lerner condition is satisfied: au − ε0 > 0 and that the workers savings rate is low,
then ∂g s /∂φ > 0 and
qε
E
(1 − sw ) au − ε0 > 0 ⇒ (1 − sw )qa > Elq ε ·
= ε0
X
εu
From the stability condition we know that g s must be steeper than g i . A negative shift in g s is thus expansionary.
du
We see that if the export elasticity is big then there is a good chance that dφ
> 0 that is: devaluation is
expansionary while nominal wage increase is contractionary. What are the mechanisms? A devaluation has two
effects:
1. e ↑→ q ↑ increased demand from abroad ε ↑. Expansionary
2. Increased prices e ↑→ P ↑→reduced real wage w ↓. Redistribution towards the rest of the world. The
sources of imports to our country is paid more in real terms. This implies increased savings because
1 > sw . Contractionary
The same effects can also follow as a result of a nominal wage decrease (A domestic wage drop is tantamount
to a devaluation)
1. W ↓→ φ ↑→ q ↑ increased demand from abroad ε ↑. Expansionary
2. Reduced nominal wage→reduced real wage w ↓. Redistribution towards the rest of the world. The
sources of imports to our country is paid more in real terms. This implies increased savings because
1 > sw . Contractionary
Devaluation has the opposite effects as a nominal wage increase. They can be both contractionary and
E
= qa that is
expansionary. How likely is it that devaluation will have contractive effects? Assume that X
e
E = P aX which means that we are running trade in zero. Then devaluation is contractionary if Elq ε < (1−sw )
• Mainly agricultural raw material exports gives small export elasticity
• Poor country gives low savings rate for workers, (1 − sw ) ≈ 1
E
< qa and it is even more likely that a devaluation is
If the country is running a trade deficit then X
contractionary. If exports are zero then all that happens when we devalue is that prices increases which means
redistribution from wage to profit which reduces demand. Which is contractionary.
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3.2
Increasing the mark up
What happens to production, investment, and growth if the profit share π increases? For simplicity consider a
closed economy E = 0 and a = 0. A redistribution from wage earners to profit earners leads to an increase in
the savings curve and to an increase in the investemnt curve. Both g i and g s gets positive shifts.
∂g i
∂g s
= (sπ − sw )u and
= αu
∂π
∂π
If demand, g i , increases most there is an expansion. If supply increases most there is a recession
du
> 0 ”profit led growth”
dπ
du
α < (sπ − sw ) ⇔
< 0 ”wage led growth”
dπ
α > (sπ − sw ) ⇔
• αu represents the profit rates positive impact on the demand for investment goods which implies increased
production/capacity utilization
• (sπ − sw )u is the change in overall saving resulting from increased profit share. Since we assume sπ > sw
increased π leads to increased saving which means lower demand.
So these two effects has opposite impact and the net effect is uncertain. If the difference in savings rate is
du
small then redistribution do not imply much more saving and dπ
> 0. Also if the profit shares positive impact
on investment demand is big we increases total demand by a redistribution from wage to profit.
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