On the short-run relationship between the income distribution-growth and debt-growth regimes

Abstract

This paper examines the short-run relationship between the income distribution-growth and debt-growth regimes using a simple, post-Keynesian, demand-driven model. While mechanisms of wage-led and profit-led growth have been revealed, their relationship with debt-led and debt-burdened growth is yet to be clarified, because arguments on these growth regimes were developed separately. This paper shows that the growth regimes transform as the regime-switching parameters in the IS balance change. By way of theoretical analysis, this paper presents some important implications for (i) the possibility of the combination of growth regimes; (ii) the features of post-Keynesian economic analysis of income distribution, debt, and demand-led growth, which sharply contrast with the basic neo-classical theory; and (iii) theoretical validation of recent empirical results. Moreover, this paper also suggests some policy implications or lessons for the combination of economic growth regimes.

Keywords:

• wage- and profit-led growth
• debt-led and debt-burdened growth
• post-Keynesian model

JEL Classifications:

• E12
• E21
• E22
• E60
• O40

Notes

1. Regarding income distribution, financialisation is considered conducive to reducing wage share and to increasing wage inequality (Hein 2011). Concerning investment, financialisation causes increased investment in financial assets, which may crowd out investment in real assets. It also undermines such real investment because firms are required to make increased payments to financial markets in the form of dividends, debt service and stock buybacks (Orhangazi 2008b).

2. For example, even Blecker (2002), which is often cited as an excellent survey of the post-Keynesian literature on growth and distribution, examined only the typology of growth and distribution. Moreover, even when such studies refer to the impact of revisions in debt and income distribution on the economic growth (e.g. Sasaki and Fujita 2012, prop. 2), these do not sufficiently consider the compatibility of these growth regimes.

3. Moreover, few empirical studies examine growth and debt finance in an open economy. Owing to this reason, this paper cannot sufficiently consider the relationship between debt and growth in the globalised economy. However, recent studies tackle this issue theoretically. Foley (2003) explains debt-burdened growth by considering the depressing effects of an increase in the interest rate and capital inflow. Nishi (2011) explains that economic growth tends to be unstable when an economy is increasingly dependent on exports and is an active participant in international financial transactions.

4. Empirical evidence supports the view that, at the macroeconomic or meso (industry) level, the debt service actually has a negative impact on capital accumulation. For example, see Orhangazi (2008a, 2008b), van Treeck (2008) and Ndikumana (1999). On the basis of these results, for analysing macroeconomic growth, this article sets up the investment function as in equation (3).

5. These mechanisms are easily understood by rewriting a part of the numerator of equation (6) as . The term in the first parenthesis on the right-hand side (RHS) represents the increase in consumption demand of rentiers from a unit of interest payments, while the term in the second parentheses represents the decrease in rentiers’ consumption of dividend and firms’ investment demand caused by a change in interest payments. If the effect of the former is larger than that of the latter, the DLCU regime is established. In contrast, when the effect of the latter is larger than that of the former, the DBCU regime is established. This is also mentioned in Section 3.3.

6. By differentiating with respect to , we get We assume that the numerator of this equation is negative, which is necessary to obtain an economically meaningful solution. For example, if the slope of F() is not negative, even when the firms’ retention rate rises, it results in a profit-led economy, although the aggregate consumption from profit decreases in this case. This contrasts with the intuitive economic explanation. This issue will be examined in more detail in the next section.

7. This is derived by the following calculation. Firms distribute a fraction 1–s_f of their net profit income to rentiers and retain the rest. In contrast, the rentiers spend a fraction 1–s_c of their financial income that is distributed from the net profit by 1–s_f. An increase in the financial income distributed from the net profit income stimulates rentiers’ consumption by (1–s_f)(1–s_c). On the other hand, a unit decrease in the wage share (increase in the profit share) changes the workers’ consumption by –1. Therefore, a unit increase in the profit share changes aggregate consumption by . Therefore, an increase in profit share necessarily decreases aggregate consumption.

8. The consumption of workers is independent of the debt ratio. If the debt ratio rises by one unit, it decreases the distribution of dividends by the firms by (1–s_f)i and raises the rentiers’ received interest income by i. Therefore, one unit of increase in the debt ratio changes the rentiers’ financial incomes by [–(1–s_f)+1]i, which is the total of the changes in dividends and received interest. This change in financial incomes causes the rentiers’ consumption to increase by . The total change in consumption by a one-unit increase in the debt ratio is therefore positive. Given s_c, an increase in s_f reinforces the magnitude of consumption expansion in the case of a rise in debt.

9. I will exclusively discuss the four combinations of growth regimes. There is also a case in which only three combinations of growth regimes exist, when the F() and G() curves do not intersect. The possible combinations are as follows: (1) a WLG and DBG regime; (2) a WLG and DLG regime; and (3) a PLG and DBG regime. This case is more likely to occur when is large. On an increase in , the value of G() increases and that of F() remains constant. Therefore, the condition for the combination of the PLG and DLG regimes cannot be satisfied. The underlying reasoning is simple. As the investment function (3) implies, represents the negative impact of increasing debt service on investment demand. A rise in this value means that demand formation through a rise in interest payments becomes more difficult, given an accelerator effect. Therefore, for a large , the DLG area is reduced.

10. This makes sense only if the labour productivity is not sensitive to change in income distribution. Suppose that the labour productivity (a = X/E) is affected by the income distribution. In the dynamic form, the labour demand is given by . By considering the change in wage share, we obtain . When the growth regime is wage-led, the first term is positive. In addition, the productivity is also affected by the change in income distribution. However, even if a higher wage share induces productivity growth, as long as its impact is not so strong, employment increases with a higher wage share. As productivity is assumed to be constant in this paper, economic growth is positively correlated with employment growth. Storm and Naastepad (2012) and Stockhammer and Onaran (2013) both theoretically and empirically explain the effect of change in income distribution on growth, and employment in more detail, by extending the concept of wage-led and profit-led growth to the productivity regime. The productivity regime is a profit-led (wage-led) regime if an increase in wages (profit) discourages labour productivity.

11. It would be useful to briefly survey the status quo of the extension of a basic post-Keynesian model. Without relying on the marginal approach to income distribution, post-Keynesians consider that income distribution is a result of market structure and class conflict among social classes. Cassetti (2003) and Sasaki (2011) have endogenised the income distribution share by employing the conflict-claiming. Ohno (2013) incorporates free entry into the Kaleckian model. By doing so, they examine the stability condition of growth regimes. The argument concerning normal capacity utilisation issues originates from the criticisms of the classical and Marxian models, which consider that the rate of capacity utilisation converges to an exogenously given rate of normal capacity utilisation in the long-run (Dumenil and Levy 1999). In contrast to their criticisms, post-Keynesians (Kaleckians) consider the capacity utilisation rate is adjusted to a normal rate, and show that wage-led growth and the paradox of thrift still hold (Lavoie 1995, 2010; Sasaki 2012). In the long-run models, the debt-capital ratio is also endogenously determined. Hein (2007) concludes the long-run dynamics is stable under a DLG regime on the assumption that the retention ratio of firms is equal to unity. Sasaki and Fujita (2012), by relaxing this assumption, show that there also exists a stable long-run equilibrium even under the DBG regime. Hein (2013) presents an alternative model that allows issuing equity in the accumulation process, which yields results that are again close to Hein (2007) with empirically plausible conditions.