 This is the last step and I want to do two things. I want to complete the story of what might be called classical Keynesian economics. And if you think about it, I try to lay out the elements of distinguishing it from traditional Keynesian economics as it been received by interpreters of Keynes. Because as you know, Keynes left his work in a highly unfinished manner. Not as unfinished as Marx, I must say. He finished one book and he was planning to come back and do more, but they had the similar characteristic that there are many ambiguities and aspects of the argument which even the most fervent Keynesians admit are confusing and unclear. But I want to focus on certain ones. First is the argument that investment is motivated by the marginal efficiency of investment, marginal efficiency of capital, which is really the rate of return on investment. And Keynes and Marx are similar in this respect. They both say that investment depends on the rate of return on investment, net of the interest rate. So we did that last time. It's the net rate of expected net rate of return. And the proof of that is clear. If you're not making more than if you can put it in the bank, then there's no point investing at all. On the other hand, if you're making more here than there, then you move it over there more rapidly. So that's the first element. And I meant to point that the difference here between Marx and Keynes is that Keynes tends to view this as a level because he operates in the short run in a static framework that is not a growing trend. And for Marx, that's inconceivable because the essence of capitalism is growth. Capital is self-expanding value. Same thing with Ricardo Smith. The thing about capitalism is that it grows. And that's why I tried to show you that data in the beginning to show you that this is not something that they were inventing. This is the signature, the genetic signature of capitalism that where it's successful, it grows. Then the second thing is that I argue that it's logically necessary in Marx or in the classical tradition, because Marx doesn't actually say this very clearly, that the interest rate be regulated by profitability because banks are simply profit-making enterprises and their competition among banks and between banks and other uses of capital will make the rate of return equal and the rate of return is equalized through the price of the commodity. I mean, if your corn price is high here and the steel price is low here, meaning that it's a high profit rate there and here it's low, then as capital flows more slowly into here the supply falls relative to demand and the price rises and the opposite here flows more rapidly, supply rises relative to demand, the price comes down. So the equalization of profit rates takes place through prices. Well, what's the price of finance? It's the interest rate. So that there you have the logical necessity of the equalization of price interest rate determined by capital mobility and competition. Now, Marx is peculiar in the following sense that there are many bits and pieces where Marx says different things. For instance, he says he doesn't believe in a natural rate of interest. But when you think of what you mean by the natural rate of interest it means an interest rate which is not dependent on other factors and I tried to show you that the logical consequence of assuming that the interest rate is in fact regulated by profitability is that what that means is that the price of finance is equal to price of finance is equal to the cost of finance per unit output and the output of finance is a loan, so cost per unit loans plus the profit rate on the capital per unit loans. Capital includes plant, equipment and reserves, very important for banks. You can measure these and that means that since these cost and capital terms are in measures are in dollars as they are for any commodity you can break them down into the real component and the price component and that tells you that really the interest rate will follow the price level in so far as the cost of bankings follow the price level which is a general proposition. If you have inflation costs go up in general so you'd expect the interest rate to follow the price level. Now as I mentioned this particular aspect is well known empirically discovered by Tuck, Thomas Tuck and then rediscovered by Gibson and it's called Gibson's paradox because in neoclassical theory the interest rate should follow the inflation rate, not the price level but in this argument you get the inflation rate following the price level and that's exactly what the interest rate does and you can look at that, I didn't do it here but it's in that chapter 11 I show all the long term data for hundreds of years that movement which was well established. Cain says this is the best known law in empirical law and economics and yet when he comes to the interest rate he has a different explanation which is that it's based on liquidity preference and there's a reason why he moves away from the loanable funds and liquidity preference but my complaint about that is that that doesn't give you a theory of the interest rate it gives you, it doesn't give you an objective theory it gives you a subjective theory because it depends on what people feel and so on but if that were true, let's say liquidity preference was true and let's say that liquidity preference made the interest rate higher then made the bank profits higher than those in other activities well those capital from other activities would be flowing more rapidly into banking they'll expand the supply of banks, drive the price of banking product down which is the interest rate so the interest rate will come back down so whatever the structure of preferences and anticipations that in the short and medium run determine the interest rate they'll be overridden by the equalization of profit rates is that point clear? now the profit rate which is relevant here is the profit rate on new investment so I measure this, I call this incremental rate of return and I measured broadly speaking by taking the change in profits gross profits because data on investment is gross so change in profits divided by investment and I thought I had invented that and I discovered when reading Caldor that he proposed it too so nothing is ever new, it's been done better before but that brings me to a point if this proposition is true then it also should be true that where there's a rate of return on other assets like the stock market the same mechanism should hold the stock market should be regulated by profit rate equalization because you can put your money into photocopy shops you can put them into the stock market if your preference structure of the stock market causes the rate of return to be higher then you get arbitrage flows into the stock market now this is an important point because the orthodox theory of the stock market says the stock market is regulated by an underlying rate and that underlying rate they say is the interest rate, the long term interest rate which is really measured by time preference so if you look at the stock market it moves up and down a lot the rate of return of the stock market the time preference by definition is human property and at least as Schiller measures it just takes a straight line all the way from 1820 or whatever the data goes to the present and he says well okay I'll adjust the level of the preference the interest rate to be so it goes through the stock market it's already making it go through but all this volatility the stock market goes up and down and this is a time preference structure and it doesn't change very much so how can you explain that and Schiller says this is the unexplained volatility problem for which he got the Nobel Prize and he says it's due to irrational movements and impulses and he built several books on it Ackerman's also Nobel Laureate has written about that so I thought let me just show you what that looks like here is the this is from in the book chapter something what is it figure 10.11 in the book on page 470 and what you're looking at here the dark line is the stock market rate of return as you can measure it from Schiller's data it's a change in the stock price plus the dividends divided by the stock price why is that the rate of return you pay $100 to buy a stock if the stock goes up $10 and already you got a return of 10 plus you get a dividend of 2 so you get a 12% return on $100 that's your rate of return that's how it's measured in the stock market all the business literature or Wall Street Journal that's how you can see the measure so here is the stock market rate of return and this is the volatility that Schiller has trouble explaining but this dotted line is the incremental rate of return in the corporate sector and you can see that these two go up remarkably similar rates and it's not like a straight line through as in Schiller but a volume and you see the average rate of return the equity market is 9.83 over the whole post-war period so I'm not picking my time periods I'm picking all the data I have and the corporate rate is 9.5 and here you see bubbles this is the famous 1990s bubble you also see busts here in the great stagflation crisis where the stock market went down very much in real terms and so here you see the bubble, the bust and that means that you can actually explain the movements of financial variables by real variables and that is really the point of competition now this is a side argument I want to just bring that up because I won't get to it otherwise and let me go back to any questions about this so one question someone asked me how come you're not rich that's a very good question I thought of that, I mean naturally once I saw this data which I did about 10 years ago, here's my problem the stock market is a predictor of the real rate of return so I haven't got any way to predict the stock market because to do that I'd have to predict the real rate of return the real rate of return is the dotted line but the stock market runs ahead of it so to speak a little bit in annual data you don't pick that up in quarterly data do but NIPA from which I get this real rate of return publishes it about a year later today because you need the capital stock you need the proper rate measure so I'm always a year behind the actual data what I need to do is be a year ahead in order to predict the stock market so if you see me arrive here next time in my private airplane you know I figure that problem out but so far it hasn't worked that's not it okay, so I'm going to skip over some of the discussion so I can get to the key point here's one point you know in the Keynesian multiplier the multiplier story is that it's static I have to say investment is going along at some level and then investment moves up and I'm showing investment as having fluctuations so that we don't just assume it's just a fixed quantity but it's going at one level and it goes up then we know from the multiplier story that output will go up more because output is investment over the savings propensity and the effect over change in investment is a multiplied effect on output so if you look at it as a time sequence as a simulation sequence this is what you would expect to see is that clear? this is a multiplier sequence that's all and that's what the multiplier sequence should look like you know from a Keynesian point of view then I make the argument that the third point of my argument which is that the savings rate cannot be fixed because businesses save in relation to their investment that is to say retained earnings is a source of financing for investment so it would be possible to argue that the financing for investment is independent of the investment plan I mean these are the same people you sit down in a boardroom and you say oh we're planning to expand and you ask the CFO well what do we got to finance for it and of course you're one of the sources of finance and I mentioned the point last night that investment and retained earnings investment look together very closely and in fact retained earnings essentially is roughly equal to investment that's a very important point because it says that most of the finance for business investment in the United States comes from the businesses themselves borrowing is expensive so if you can finance it internally that's fine otherwise you have to borrow and then you pay it back and it's interest payments and so on so that means that the multiplier is always partially endogenous because the portion of the multiplier of the savings rate which comes from business savings has to respond to investment so the whole Keynesian fiction that investment rises and the savings rate doesn't change which is a source of the multiplier cannot be true so part of that in John Gennady means that if investment rises and the savings rate rises as much there's no multiplier if investment rises and savings rate rises somewhat then the multiplier is damped right? so the damping depends on the sensitivity of business savings and household savings to investment and there are different mechanisms and channels but I bring that up because when you look in the literature and you say why do they assume that the savings rate is constant it turns out it's algebraically convenient and that's not a hell of a good reason for theory, it really isn't Kolecki says, for instance of course business savings is related to investment but I'm going to assume that savings is determined by aggregate income which is now business income and personal income and that's a fixed proportion because what? because it gives a simple story the trouble is that's fundamentally a mistake you can't let algebra determine things like that and it turns out it makes a big difference to the story so that's a third thing the fourth thing was that capacity utilization is roughly fluctuates around a normal level I mentioned what the normal level of capacity utilization is the lowest cost point on a cost curve but the actual cost curve is a curve with many wiggles because different shifts come in and they change the structure of costs and then they go down they go from first shift to second shift you have to shut your machinery down that means to start it again you're starting at a level where it's not fully running so your costs are higher moreover a second shift is often in the evening then you have lighting costs that you don't have during the day you may have heating costs in many countries usually you have to pay a premium to get people to work in the second shift so your cost structure goes up so it's not surprising that the cost structure of actual firms has got these wiggles due to first, second, third shifts there are 24 hours in a day and the cost curve has to encompass the output over all 24 hours so a business cost curve and the one I've shown in the book is for General Motors it's got these wiggles so the lowest point on that curve is the point where firms would ideally like to operate because that gives them the biggest advantage in the market so that's the same principle as saying that firms are driven to have lower costs they're not just driven to have technology with lower costs they're driven to operate their technology at the lowest cost point it's the same principle and this point was actually discovered by Harrod when he abandoned his idea of imperfect competition and switched to a different notion which was in the 1930s nobody remembers that but Harrod worked on trade, on micro imperfect competition and monopoly power and that stuff so that's the fourth point and the fifth point is that or what did I say, fifth point yeah is that accumulation is a function of the rate of return minus interest but in the case of Marx it's not the level of investment it's the growth rate the growth rate of capital divided by capital stock now you can think of this as a way of normalizing investment that is when you if investment is growing over time then you have to treat it relative to something you can treat it as relative to the capital stock or relative to output whatever you do you recognize that investment goes up if net profitability goes up faster and again this is not a difficult argument to make from the business literature but it's surprisingly difficult in the economics literature okay now let me get to the sum result of all of this I made this point before but this is a point worth emphasizing that the point about capitalism is best understood by Keynes and Marx of course but Keynes especially here says the engine which drives enterprises profit now what does that mean it means that firms make production plans with the anticipated profit in mind profit and production they don't do it because they feel good or look shiny or anything like that they do it because they want to make profit but when they decide to make profit it means the planned production it's based on expected profitability then also it means that they have to make decisions to hire workers they have to make decisions to buy raw materials they have to make decisions to fix or expand their plant and equipment so therefore the demand for materials the demand for consumption goods from workers and the demand for investment goods and then they also have to pay in order to run a business rents and interest and dividends which are property income so that's a source of income for the demand for consumers for consumption for property goods for property income so you have workers consumption and capitalist consumption you have raw materials demand and you have investment demand coming from the same motive that means that demand and supply are both regulated by profitability it doesn't follow that they match for obvious reasons because all of these are individual elements flying out of the decisions of individual firms and there are different aspects of profitability the production profitability is short term you decide every month whether you're going to keep the shop going or whether you're going to close it down if you run a coffee shop you decide do I get customers or not if you're on the other hand making a decision to expand then you're not concerned with what's going to happen next month you're going to be concerned with what's happened over the next couple of years because it costs money to set up a new coffee shop and all that and you don't want that money to be wasted so you may be looking five years ahead you may be wrong that's not the point the point is short term look ahead for production long term look ahead for investment there's no reason why the sum of all these individual decisions made by firms and then the consumption decisions made by their workers and the consumption decisions made by their property owners and their own investment decision why should I add up in fact one can say obviously they won't add up you can do this yourself by the way you can use an agent based simulation model in model this and you'll see that the sum of these decisions will not add up so therefore you need a rule which capitalism has which is to bring them back into line and that's the whole rule that we're going to talk about now aggregate demand and supply and all of that so I want to emphasize that whereas neoclassical economics says that macroeconomics is supply side that is to say given the supply of labor the system will move towards full employment output how does it do that if for instance the supply of labor if for instance the wage rate I'm sorry if for instance the supply of labor increases then the wage rate will go down and this will make it more profitable to expand production and therefore you'll hire more workers and the wage rate will go up to the level that creates full employment of labor I'll go down to the level that creates full employment of labor vice versa labor supply shrinks so if they have the argument that all labor is fully employed automatically from the internal mechanism of the system then you can say that the output of the system depends on the input which is labor technical change which changes the relationship between the input and the output so this is basically supply side economics this is what Bob Gordon does in his book on productivity growth imagine productivity growth on the assumption that the determination of output is entirely from the inputs and technical change and therefore any changes that he sees must be due to those two factors and productivity becomes the central thing but Keynes if Keynes was there he'd be going I know Professor Gordon you're totally wrong because in fact demand is the source of the growth of output so Keynesians say macroeconomics is demand side it's driven by demand in the short run and therefore employment depends on the level of demand and output growth is therefore driven from the portions of demand that are autonomous which is investment demand in Keynesian theory employment spending and so on so you have a different theory of demand I'm arguing that neither one of these is correct because they misunderstand that both demand and supply are regulated by profitability it's not supply side economics it's not profit it's not demand side economics it's not say is law it's not Keynes is law but the law of profit which is that both sides are regulated on both sides any questions here I talked about the savings rates let me get down to showing you some classical dynamic show you some pictures because it's in the book so let's go to the question yeah sorry Keynesian in response what's the landowner profit determine would argue that profit is determined by demand but basically you're saying that because of the envisioning of savings that's an incomplete argument no that's a good question so let me clarify that Keynesian say that the amount of profit is determined by demand I'm talking about the rate of profit and that Keynes is marginal efficiency of investment and even they don't say that's determined by demand though in the short run demand stimulus may create animal spirits and all that but as I said the key point that Keynes fudges with his aphorism that in the long run we're all there is exactly the point about what determines these factors and it's a mistake to think of it as in the long run think of it as fast and slow this is an important distinction fast and slow is like the difference between you're doing something now and you're still up over time like environmental degradation is slow environmental pollution is fast we totally understand now that you can't simply say that because in the long run I'm dead I don't need to worry about pollution I don't need to worry about effects because these effects are cumulative and in many processes engineering is a fast example you have faster slow processes the thing about fast and slow is that they operate at the same time they just operate at different speeds and so you can say well I'm going to ignore the slow for the moment if it's slow enough but you can't ignore the slow over time that doesn't make any sense because yesterday's slow is today's current effect so you can't do that so mathematically you have to have both of them going at the same time and that means by the way another type of mathematics need the mathematics that allows for different time speeds and that's well known in engineering but in economics it's known in economics we say short run nothing changes with investment long run demand and supply are equal and investment actually both are operating you have to show how they operate and you have to show how they influence each other so let me give you the example in the case of a shop you run a coffee shop your coffee shop customers come in if they come in a lot more today you get excited but you're not going to hire five more workers I mean that would be crazy but if they start coming in every day on a regular basis and you think okay this is actually a short run increase in demand that is a signal and I'm going to hire another worker now if this happens over months or you think it's going to happen over months or years then you think well okay I need to expand my shop maybe I'll open another one nearby that's an investment decision and that's a slower reaction because you're going to look ahead more the short run is a short look ahead because tomorrow may not come again so that difference is not something that happens at a different time they're both going on at the same time it's how you read the signal that's the important difference okay so imagine now I want to show you the results of the equations that I described in the book about how these processes work so imagine that you had a growth path of output around some trend this is what you would expect to do if there was no stimulus nothing going on output is fluctuating around the growth path in the sense that the profit rate and the interest rate have determined a particular growth path and there are shocks and local fluctuations that cause you to move around that growth path right so we said the growth of output growth of capital rather growth of back up a bit this is what we're looking at the growth of capacity and hence the growth of normal output is a function of this term which is the profit rate minus the interest rate at normal levels plus a series of other terms having to do with technical change and shocks you can partition out the part and focus on the effect on profitability so I need to separate them out in practice of course they're all done together but you can actually measure we're going to look at the measurement to see how you can separate these parts out so we're concerned with the growth of output depending on net profitability depending on the change in the capital to output ratio at normal capacity and shocks having to do with demand supply capacity utilization and stimulus demand supply fluctuate around each other so zero mean capacity and output fluctuate over longer time so zero mean over a slower process not longer time in the sense of it happens in the future it happens more slowly and then you have the technical change element which I'm going to come to in a minute so imagine that this output this process of normal output is given by two variables the normal share of investment and the output to capacity ratio capacity to capital ratio and if you had fluctuations around it then we would expect all other things being equal the path would look something like this because all those other terms the demand supply capacity utilization that's going to cause fluctuations around the output on the equilibrium path right so that's the base expectation that you will see fluctuations around a path but the path depends on net profitability and this is very important so now let's look to see what would happen if you have a stimulus I'm sorry if you have a drop in net profitability since the path depends on the normal profit rate minus the normal interest rate if that goes down then the center of gravity of the adjustment will itself be going down because this is the slope is dependent on that path so on the normal net profit rate so you would expect the fluctuations to adjust to a new path so you would get something like this rather than previously like that that's just breaking down the results into the profitability effects and other effects but here I'm simply saying that this profitability effect is independent of the other effects but suppose you had a stimulus a temporary stimulus well a temporary stimulus which doesn't change the normal profitability path would raise the level but not the rate of growth that's an important thing about growth paths in growth paths the paths are parallel they have the same growth rate because this is a log scale so if they're growing they're growing at the same rate but the level depends on a stimulus so this is the truth of the Keynesian argument if I have a stimulus for whatever reason then that stimulus is going to cause me to ride to a new level and the growth rate will be unchanged because by assumption I haven't changed profitability everybody with me here this is a difference of shifting from a level argument to a growth argument and this is kind of neat because this allows you to see the truth of the Keynesian argument which is that the level does change and Keynes says well when I'm the growth rate I'm taking to be done in the way I'm going to run I'm leaving it unchanged and this follows by the way from a simple simulation all these simulations are just the equations run in Excel or whatever and they're in the book web page which is called really con.org the data, the simulations everything is there so you can do these yourself too but now this is a temporary rise so what temporary is that it causes a change in the level and then you come back to the same growth rate but suppose that you have a stimulus which causes the system to rise to this new level but that stimulus causes the share of wages to rise relative to output remember I argued last time that this is very central if a stimulus pumps up the economy doesn't affect profitability then you don't have any problem with things being equal you're on the same path of growth as before but you're just on a higher level but if the stimulus undermines profitability if it runs into that then what you're going to see is this Keynesian bump what you won't see right away is that the now the system is fluctuating around a lower growth rate so what you've done by the stimulus is you pumped up the level but if you slow down the growth rate at some point you'll be fluctuating at a lower level than you would have otherwise doesn't follow it will be lower than you started but it could be lower than you started depends on other things that happen if this is extended down as soon as later is going to cross the old path that means at some point other things being equal you're fluctuating around either the same level or a lower level so it's possible that a stimulus could lead to a decline in the rate of growth which would cause unemployment to rise unemployment to rise and even a fall in the level of output later and that follows simply from the logic of the argument that growth depends on profitability and stimulus and the stimulus raises the level but insofar as it inhibits profitability it can negate itself over a slower process now if you don't look for this what you're going to see what you'll see is a stimulus has this boom and then you go for some unknown reason it dies out and this is important because in post-Keynesian economics structuralist economics profitability cannot be hurt by stimulus because profitability comes on the markup and firms choose the markup they want so why would they choose a lower profitability that doesn't make any sense so the profit rate can't fall yet the idea that a stimulus is always good but I argued in part earlier one of the earlier lectures that is historically that is exactly what you don't see the first great Keynesian stimulus was Hitler and he had a tremendous, it wasn't him really it was finance minister Schach who had this tremendous boom caused by deficit spending and purchasing power printing and they went from massive unemployment to full employment within one year remarkable nobody had ever done it before the next one, big one that I focus on there are others in Europe and all that but the US wasn't impacted by the war in the same way so it's cleaner so to speak is US war effort 1929 the economy falls into a deep hole it sort of fluctuates around and it's not recovered yet and by 1939 it's climbing back on and the US begins the post war begins the war effort it begins to repair because Roosevelt already knew he was going to get into the war but he waited until 41 so they begin to prepare and in 1941 so already you can see this rise and we know that because we know they began to prepare for armaments and all that and you see the rise in employment and output there is a big rise in World War II and then in spite of that the rise is not negated so hang on one second so one of the two things that tie these two together the fact that there is no negation in other words that it looks like the other one looks like this is that they did not allow in either Hitler's Germany or US's war effort prices to rise they had wage and price controls and productivity on the other hand rose so real wages didn't rise very much or perhaps didn't rise at all and the wage share fell because workers were told this is you have to fight we're fighting for our country you have to work yourself as physically as hard as you can as long as you can and so the war effort produces big increase in the length and intensity of the working day hence in the productivity of labor and manufacturers were encouraged because after all the nation was at risk same thing in Germany and in both countries the profit rate rose and you can measure that in the 1970s it's a different situation it's peacetime workers are not under any stricture and so what happens in the 1970s you pump up the economy wage share starts to rise I showed you that in the graphs before when the wage share starts to rise that was also before profit rate falls you're now undermining the growth rate unemployment begins to rise they think oh we didn't do enough stimulus so bang hit it again so then you get another stimulus and you get inflation well in phillips kerf tells us it's okay well a little bit more unemployment creeps up so they hit it again and what you get is unemployment rising in theory because inflation can only come when you have full employment and you have rising unemployment and you have inflation wiped out Keynesian economics in Stepp Friedman and Phelps and changes the whole history of economics from beginning in the 1980s and with the Nobel Prize also which was invented by the Swedish central bank in order to support right wing economics you get this change the book I mentioned it before I think called the Nobel Factor which is a book about the history of the Nobel Prize written by a professor at Oxford historian who got access to the archives of the Swedish central bank and the book is about how the Swedish central bank set out to change the way economics was understood move it towards what we would now call neoliberal economics support because the Swedes and the Europeans and the Americans were saying following Keynes that you need to intervene to keep a capitalist economy going and they said no free markets is the right way to go and so Friedman Stamelsson, Friedman, Solow the whole gang so to speak Chicago, MIT came from the Nobel Prize came from the Swedish central bank and you know it's not a Nobel Prize yesterday Krugman was talking about it he called it the Swedish thingy because as he said it's a bank prize from Sweden and it's not a Nobel Prize so he called it the Swedish thingy well the Swedish thingy was set into motion to change economics and it was extremely successful because now everybody thinks that the right point of view is of the people who gave the Nobel Prize who got the Nobel Prize and the politics of those people have changed a bit because times have changed but the economics of those people hasn't changed because it's still based in your classic economics Krugman said yesterday that he thinks now economics took a wrong turn 40 years ago 40 years ago was when the Nobel Prize started to push economics in that direction and that's why he was calling it the Nobel thingy because he's certainly aware that he's part of that turn he's very progressive but he got the prize but also because he used standard theory as the foundation for his argument George Robinson didn't get it because she was too anti-neoclassical I mean she was openly anti-neoclassical Caldor didn't get it Kahn didn't get it Galbraith didn't get it I mean the list is very long anyone who was critical of market capitalism didn't get it and then later they began to have people who are critical of the current form of market capitalism one of them is critical of market capitalism so the Nobel Prize has a function and a big effect ok so my point here is that you can make sense of these historical phenomena the last example I gave it's in this paper which I'm going to put on my home page now which is on the book web page Marian put it on it's called conditions for successful stimulus or something like that and the point is that if you get into the realm where the stimulus undermines profitability then what you're doing is pumping up the level but just slowing down the growth rate and that means that you could end up with a lower output level and you certainly could end up with higher unemployment because the supply of labor is growing so the unemployment rate could be higher and that's exactly the problem we observe Brazil had two governments very progressive but they discovered to their great chagrin and political detriment because they then lost power that inflation began to go out of control and the growth rates slowed down and if you look at their own estimates profitability fell so the private sector was in effect damaged by the stimulus because of the rise in the wage share so this is not this is the kind of fiscal crowding out but not due to the interest rate or anything like that it's due to the fact that the wage share rising lowers profitability any questions about this I'm going to end there because I want to talk about the crisis so I want to switch but the crisis is going to be linked to this the point about crisis is how do you solve a crisis and the answer on the right is austerity lower wages, increased productivity lower costs and the answer on the left is stimulus my point is that those two are not independent they're linked if you have the austerity first you get what Krugman was talking about correctly yesterday was that you get much damage to the citizenry standard living poverty output employment fall but it does in fact lower wages which is the point if you get austerity but then either you pile up a huge deficit and debt certainly if it's a foreign debt you have to worry about that if you don't have your own currency you have to borrow from abroad and that debt can undermine everything and also the profitability falls you lose competitiveness it's not just profitability but if your costs are high unit labor costs are high competitively you're behind this is the greek story so we need to be aware that what we would like to see can be done but you have to understand the limits of what we would like to see and nobody would be surprised if I said yesterday someone asked Krugman what do you think about the $15 wage and he said you know broadly $15 is okay but above that maybe he's right nobody knows for sure but it seems feasible but what if someone had asked him what do you think about the $50 wage minimum wage would have a negative impact because on one hand it would give poor people who have minimum wages a lot of money on the other hand it would mean that firms would have to pay $50 for the same worker they were paying $12 before and nobody believes that that would have no effect on employment so yes workers would have more wage per worker but there may be a lot fewer workers who are employed Keynesian strictly speaking would have to argue that has no negative impact it would cause consumption demand to rise because they don't make a link between consumption demand and the investment demand through the cost of wages and the effect on profitability so I'm going to stop there because I want to get to the crisis yeah what kind of is that is that right I don't think I said that you can pump up the economy so let's go back a little bit that's a good question so if there was no stimulus then the economy would be fluctuating around some path dependent by dependent on net profitability and it's not technical change technical change comes from the idea that you have a production function so all the labor is fully employed if there was no technical change an output would be dependent on the input productivity the production function has a shift parameter which is technical change or change parameter so the amount of output you get from an amount of input changes over time and that's technical change in the original solo thing it's A which is the solo's original neutral technical change is that output is a technical change parameter times capital and labor these are time variables but capital is built to accommodate the full employment of labor so that's kind of endogenous and the production function allows you some flexibility in their use so the key driver is the exogenous variable so capital is endogenous but technical change is also endogenous so basically this relationship determines a certain amount of output per unit worker and productivity change changes the output per unit worker through technical change so that's the idea that growth is driven by technical change but I'm not making that argument I'm making a different argument that growth is different by profitability and profitability has impact on technical change I mean technical change has impact on profitability but that impact is not so simple and that's what I want to come to next technical change can actually undermine profitability a profit type of argument so I'm going to come to that okay any other questions here? yeah that would be the first one then whose model? Goodwin model and the second one is what is your position in regard to you know some alternative theories that are used in the business output by relying on different underlying mechanisms like a Dorian definition of the business output one thing at a time Goodwin takes his argument from Mark so the Goodwin model is a mathematical formalization of the argument about the reserve army of labor so obviously I didn't talk about that here except to say that the key point of the reserve army of labor argument is that when you tighten the labor pool you narrow it then capitalists have an incentive to bring in more workers or displace them more rapidly through mechanization so it's not like capital is not passive and it's important that the technical change is always endogenous it depends on the incentives that capitalists get one of which is to cut costs but they can also change the balance between capital labor in this process so Goodwin does talk about the model of thing of great beauty but it doesn't encompass these aspects for instance in the Goodwin model which you'll notice and I discuss this in the book at some length is that the wage share is given by the parameters of the model because technical change is taken to be given, the productivity growth and so the constant rate of unemployment produced by that gives you a particular wage share now what does that tell you? It's really amazing the model says that the workers have no say on the wage share the same thing that many models do that the wage share is a result of technology. In the case of the Goodwin it's a result of keeping the labor supply and the labor demand equal and the wage share does that adjusting so therefore you can't have a wage share which is dependent on class struggle for instance and that's even more so in the long run say a Harrod model and I discuss this at length in the book so one of the things is what's wrong with that and the wrong, in my opinion part of it that's wrong is the idea these parameters are sort of fixed that is to say the labor pool won't change because capitalist technical change won't change and respond to this the capital labor ratio won't change so I take the Goodwin model I expand it to incorporate the kind of argument that he was supposed to be modifying, representing which is in Marx and you see that it changes the story completely so you are basically... Well the wage share depends then on class struggle, that's a key point so that means that wage share is historically determined and given that you have other factors that can narrow or widen the reserve army of labor and affect the wage share from that too and obviously these are historically you compete on a particular ground if there's low unemployment then you have the advantage if it's high unemployment they have the advantage so I develop a whole story of that and the wage share curve which I grew last time is about that it's an actual empirical curve I didn't draw the curve, I just trace the path of the economy and of course Caldorian and other arguments are based on partial I'm trying very hard to show that the same framework gives you answers to all their questions and gives you a different answer because they always leave out something and this is not a new framework you can be tracking it back to Smith and Ricardo and Marx, it's at my main point what I see is that you're saying that the denation multiplier I mean the role of the denation multiplier in explaining the economic situation is actually low so if we don't have this interaction between the denation multiplier and the investment we cannot have the kind of Caldorian side but it's not the accelerator because the accelerator is essentially a linear relationship that comes out of this and you can have a Caldorian accelerator which is a non-linear but it's missing the point for me the connection is between the effective demand impulse which is the pumping of purchasing power and profitability the relation between these two can be formulated in many linear, non-linear ways but that central relation tells you that when you run into the limits of profitability you get into trouble now I formalize this in the book I'm skipping that but the main point is that formalization has to be true to the underlying economic logic models are there because it's supposed to represent some underlying argument and the Keynesian doesn't have that argument and the reason by the way is that Keynes's argument the interest rate and the profit rate are exogenous they're not linked back to the conditions of the wage share you know I haven't discussed here but the Caldor-Passanetti models were all attempts to solve a problem for women, Harrod which is if the rate of growth of the warranted path was determined by a parameter then the unemployment rate could not be stable because that rate of growth could be faster than the rate of growth of labor supply which is called a natural rate of growth in which case unemployment would fall progressively to zero or it could be lower in which case it would rise above so then Caldor and Passanetti tried to figure out what's wrong with that Harrod took the savings rate as fixed so they said the savings rate depends on the savings of workers and the savings of capitalists so the wage share will make the savings rate adjust so that unemployment can be constant in the long run but that then means the wage share is dependent entirely on accumulation and workers have no say whatsoever and that's completely contrary to all historical evidence so these are wonderful models Passanetti was my teacher I adore him and he's a brilliant man but I'm making an argument which is different that the wage share is primarily determined by class struggle and unemployment and that's why the curve shifts when the class struggle shifts by the way and then from there the theory has to be linked that to profitability from that to growth and so some of the mechanism looks the same but it's a different story completely different story and the thing is I don't see these as model models they're ways of exemplifying theory and so the thing to keep in mind is the theory what is the theory? a model is just a way of representing the theory and we always know models are useful to bring up some aspects but they're not complete nobody would say that so keep your eye on the theory well that's right I think that's right but remember that these variables here in the short run dependent lots of other factors I'm saying that they're linked in some fashion to the normal rates but these other relationships is exactly where Minsky can enter as well as effects of interest rates and all of that and so you need to have the Minsky side but you need to link it one of my students by the name of student Schroeder who did a dissertation on the Asian crisis showed that you can take the actual profit rate and the interest rate and show the point where the crisis becomes a risk and causes collapse when the profit rate hits the interest rate which is what I'm coming to now and that is a sort of Minsky when you're not making enough money to pay the interest equivalent you can think of that as a Minsky it's not strictly speaking but it's close the same idea those two variables are playing here so you could go back and see Minsky from a different point of view which is not a short run point of view but the short run fluctuations in the long run perspective in a slow I say long run but I shouldn't be allowed to say that should be fast and slow okay so now I told that story let me close it and I want to talk about the current crisis oh it's a power point clever okay need that anyway okay what I want to do here is to try to explain the crisis on the basis of the same theory so I'm not free so to speak to invent the theory of crisis and one of trade one that's stock market and one for aggregate demand because the fundamentals they have to be shown to be acting in the same in the in different domains but they're acting the same fundamentals that's a key point of having a theoretical foundation so and this is based on my book as I said you can go to realecon.org and we have all the data and reviews of the book and all kinds of things and spaces for people working on these projects to share it with other people so that people know that you're working on them and since more than one person may be working on the thing you're interested in you hopefully we can create some kind of community from that and as I said the point of the theory is that we're looking at actual capitalism not economic theory I am not interested in that sense in what Caldor said or what Goodwin said or Minsky said I'm interested in what the real phenomena and then I look to see what they said to compare to the real phenomena so this is not a history of thought this is an analysis of scientific analysis of capitalism and they enter in so far as their explanation is revealing of some basic things and what we're talking about now is chapter 16 I'm gonna skip chapters I won't get to chapter 17 but that's where extensions and applications of the work to many other domains inequality the effect of the state welfare state on wages and incomes of workers and benefits and also the issue of development here I'm focused on the developed capitalist world and I mentioned before why that is when I went to graduate school at Columbia they said oh where'd you come from Pakistan okay so you must be interested in development it was typecasting you know but the fact is I was interested in development so I studied development what do I see they apply these neoclassical models of development I'm going this is junk you can't be serious you have to do that because we do the real theory and you just apply it so I refused and I've spent the rest of my life trying to work out a proper alternate foundation that covers the same bases so to speak and I urge you to think about that I'm trapped into thinking that all we are capable of doing is applying their foundation but we're capable of creating a new foundation and creating a movement around a new foundation it sounds like Bernie Sanders I know but I do believe that so think of it that way so I want to make the first point the mortgage crisis is often said to be caused by the I'm sorry the current crisis is often said to be caused by the mortgage crisis and that it seems to me it's an elementary mistake which is the difference between the trigger and the cause now I'm of the age that when I say this it's meaningful if you have a heart attack because you win a lottery it's not the lottery that caused your heart attack it's because you have a heart condition that triggered your heart attack and it could be good news or bad news you could have lost a lottery and it could cause a heart attack so everybody understands this there was actually an article I saw in the New York Times and in Brooklyn who won the lottery and he got a heart attack I don't think he got it from the lottery he got it from the pressure of all his relatives who wanted him now to give him all the things they needed because he got a lot of money and he gave him a heart attack but we know that's not the cause that's just a trigger so once you understand that then you have to understand what caused the underlying build up of the that led to the mortgage crisis that was caused by other factors and that happened to burst in Florida first before it spread to the world but it would never have spread it's not the first time Florida has a mortgage crisis or something that spread because the rest of the world was also this huge bubble and so we need to go back to say where did the bubble come from and when we do that we go one step back because either we say based on bad actors Bernanke or whoever we want to blame or some underlying fundamental and I'm going to show you the fundamentals make this story very straightforward we say sometimes well this is because of deregulation first of all deregulation has been going on for some time Clinton signed in things that allow banks to escape the regulation that was set up in the Great Depression to protect banking systems but who made Clinton sign it the answer was the banks the banks were giving a lot of money to congressmen as they do nowadays it's no secret you can buy a congressman pretty easily and senators are more expensive but you need to get their support and they push this reason of this idea of bank regulation on the grounds that all these profits being made that we can't get into because you say we can't take risks so we want to take the risk because we'll make the profit and sure they deregulate it and bang you let the banks go so regulations have an important factor they can slow down inhibit but what they slow down inhibit is profitability and the state is never independent of the interest of the driving force of the system which is capital so the state gives in and it's persuaded by to define efficient market hypothesis rational expectations we don't need all this stuff you're just messing things up the market can handle it so the regulations in fact Friedman says the great depression was caused by the state it was not capitalism so all those regulations meaningless let it go and they let it go and we got what could have been entirely expected boom in the first place sometimes you say it's green spans folly and I'm going to argue on the contrary that what we got was a structural crisis and moreover it was absolutely on schedule these structural crises run roughly 40 50 years these are called long waves but they're part of the long wave cycle and they're not new and every time they occur people say I was done because of what's his name or what's that policy and then it happened again and there's another policy and another name attached to it but they don't look at the one name which is central which is capitalism itself it's a process it's a system I mentioned this demand and supply come from the same incentives but from different aspects of profitability and they don't necessarily meet their regulation is precisely through overshooting and undershooting and that long undershooting and overshooting is very important economic historians speak of the Great Depression of the 1840s where two young men were trying to overthrow capitalism because of the misery caused by that and there were Marx and Engels in the streets in Paris Marx Engels in Germany 1880s you have Freud writing letters saying I'm very worried about what's happening I don't know we might be pulled into a war we might have any work and so this is 1930s we know Great Depression mass unemployment left movements all over the world and then right wing movements all over the world with Hitler and fascism in Spain and Italy 1970s the Great Stagflation inflation rising Keynesians are in power they're supposedly controlling the system the system is getting out of control and some of them were sharp collapses 1840s and 1930s off the cliff others were long drawn out periods the 1870s was called the Long Depression because it's 1873 to 1893 in Europe 20 years people were thinking capitalism is dead because it's just in this deep depression but eventually it pulled out 1970s the state intervenes viewed as the cause of this because it's a welfare state but it tries to prevent as banks fail and unemployment comes it tries to prevent that and that leads exactly to stagflation and I believe that we're simply in a Great Depression now this is the first Great Depression of the 20th century 21st century and it's not new they had one they had them in the 19th century they had them in the 8th in the 20th century and we've had the first one in the 21st century and if these patterns continue then you should expect two in this century so someday you may be giving a lecture at my age to people saying I saw these two and this is a new one actually I was associated with profiting through a non-finance corporation I'm coming to that so please save that question and I will try to explain how that happened we start from the same my point throughout is to show that these very simple propositions explain many different things effective demand, profit rate equalization all of that relative prices stock market prices but here we're looking at the aggregate and we're saying that accumulation is driven by the net profit rate and we're going to look at the data we're going to look at this measure the profit rate is a rate of return on new investment and the key point is that when the profit rate approaches the interest rate then that's telling you that the profit on new investment is not any more than if you'd left it in the bank and this is actually the formal argument that Marx makes which he calls the point of absolute over accumulation he says the point where the massive profit of enterprise which is the profit rate minus the interest equivalent is stagnant means that you just add it to capital which is what investment means and you didn't get any more profit so that means that capital is wasted so what happens he says and begins a withdrawal of capital but the withdrawal doesn't start with the newer investment starts with the older one so you get a phase change in the behavior of the system Marx calls it the point of absolute over accumulation Grossman, Hendrik Grossman makes a big thing of this in his argument and this triggers a phase change in the behavior of the system literally mathematically a phase change and the long boom turns into a long downturn and of course then you get all inherent problems become exposed I love this quote from Warren Buffett which is that you only learn who's been swimming naked when the tide goes out and this is the point when the tide goes out and then suddenly all kinds of things begin going they did that I can't believe that but things were so we're going to look at what they did how they were when they were in the tide going out so I'm going to show you the path of the general rate of profit the path of the interest rate the path of the rate of profit of enterprise the difference of the two the total amount of real profit real wages, productivity so on and household debt and debt service burdens so let's see what the first of all very important when you're looking at profitability to distinguish between actual profitability and actual profitability and normal profitability so I want to show you how that can be done the profit rate is profit over capital and you can break it down into profit over output these are a flow-flow ratio so they fluctuate but not as much then you have output over capital but we can break output that into output over normal output and normal output over capital so what are these variables this is the profit share now strictly speaking you want to get the normal profit share and you could do that by taking some kind of HP trend of it to the center of gravity of the profit share there are fluctuations here profit fluctuates more than output so there's some fluctuation but these are flow-flow ratios they don't fluctuate that much this is the rate of capacity utilization and this is the normal this is the capacity to capital ratio why is it distinction important the profit share when we talk about the class struggle it's a balance between the division of value added into wages and profit this is Marx's surplus value over value value added so it's s over v plus s this is the fluctuations due to effective demand this is going to cause up and down you pump up the economy and you get capacity utilization will rise but then businesses will put in more plant and equipment capacity rises so the utilization comes down so we expect this to have a slower this is the slow adjustment process and we expect that to be immediately affected by large pumping but then disappear because capacity rise everybody understand that so you're running a business and I throw some money at you the first effect is your sales will go up if the sales go up sufficiently you put in other businesses you get more machines or more photocopies machines if your business goes up your capacity goes up and you keep doing this until your capacity can handle the business we're just throwing at you so then capacity utilization comes down because initially you're using the same machines and working three shifts you add more machines and more workers and you go back down to two shifts or one shift if you're running a photocopy shop at 8 o'clock or 10 o'clock depending on where you are but if you get a big jump you might work all night to get it finished but then as you add more machines and more people you bring your capacity utilization down so it can be actually fairly fast it doesn't require 10 years it depends on the machine same thing for bakery for oil refinery it takes much longer so this has got its intrinsic dynamic and this I'm going to call utilization of capital and this I'm going to call the maximum rate of profit the normal maximum rate of profit which is the ratio of capacity to capital now in this formula that's the technical change part this is Marx's ratio of living labor to dead capital at normal capacity utilization because we want to distinguish between the technological part and the psychological part which is this and the utilization of the technology which is this again from the business point of view this is trivial and obvious but in economics we often forget these distinctions so we have three variables profit share capacity utilization and the normal rate of profit normal maximum rate of profit Sorafa calls this a maximum rate of profit because if all value added went to profit it doesn't all go only some of it goes but it's the upper limit and it's determined by the technology and that's the beauty of it and the length and intensity of the working day so one is determined by conditions of production the other is determined by conditions of utilization and the third is the class struggle so it's a nice separation and it's a familiar one if you think about it when we talk about any of this literature so then the question arises how do you measure capacity utilization well there used to be measures there used to be a measure capacity utilization which was based on the utilization of electric motors in manufacturing why because electric motors are installed with the capacity that's the maximum that they can engineering capacity so you could see how much they were being used because they would have to report the horsepower of the actual usage of the motor so you had a wonderful built in capacity utilization measure this was discovered by Murray Foss subsequently at the American Enterprise Institute it was a great measure because it was directly observing the utilization of the capital stock which was all driven by electric motors unfortunately the Bureau the Surrey of Current Business and Bureau of Economic Analysis stopped asking the question so you had this wonderful data going up to a certain point then disappeared then I discovered another data source which was asking people businesses how do you use your capacity and that survey method so this was survey of the actual utilization but the other was just verbally and by going through and reading how it was constructed I showed that you could duplicate the Foss data with the survey data and that was done by McGraw Hill and then McGraw Hill stopped asking the question so that data disappeared after the problem the data disappears in the 80s I'm working on this book in 2012 and I began to think about how to think of this problem so here's what I came up with let me see yes the ratio of output to capital which is this part here can be written as the ratio of output to capacity and normal and capacity to capital this is just an identity right so this is just an identity now if I take the logs of these bring the capital stock actually bring the capital stock over to the other side then you get the log of capacity utilization plus the log of capital which is here plus the log of the maximum rate of profit now we have data on the capital stock we have data on the output so this is called an unobserved components model in econometrics and if you have a hypothesis about this you can estimate this now this is a variable of technical change this is a slow movement to accretion of technical change in individual firms so it's not implausible to say that this is a function of time now we try different functions of time but a linear function works really well so this is basically a technical progress function in the sense of Kaldor it's about the capacity capital ratio so if you do that it's a regression because then capacity is that part that is linked to capital stock and if you run the regression or you make the assumption that over the long run capacity is approximately one over the slow process you can run the regression I talked about in the book at length and you get capacity is that portion of output which is cointegrated with capital stock subject to a time trend unspecified time trend and the estimates will give you the direction of this so when you do that you get a capacity utilization measure which looks like this and I tested it against the data that I already had for electric motors and survey methods so when I did it for manufacturing it gave a very close result for actual manufacturing now this is the economy as a whole and you see here the Vietnam War boom beginning in 1960 because there are normal fluctuations it begins a little bit before but this is going down it comes back up and here's the boom to the peak of the war and it comes back down because first the boom is a huge expenditure of deficit finance expenditure and businesses are thriving but then they're adding to their capacity so the utilization rate comes down so they bring it back actually to a normal utilization rate and then you get another boom in the Reagan era which is again deficit finance Reagan was the biggest deficit of all and you get this boom so you can see that there is a sort of normal a tendency, a central tendency of around 0.9% 90% rather utilization rate in this data and you get these long booms long waves and these long waves make great sense when you look at the business literature about what's happening but the other data is data from the Federal Reserve and you see the Federal Reserve data it just has these small fluctuations why? Federal Reserve is based on a production function production function has no room for effective demand so they estimate a production function on the assumption that all labor is effectively fully employed just some unemployment rate changes so of course they define potential output from the production function and this is important because theory determines your facts and you have to understand that on the underlying theory measurement of the capital stock measurement of profit, unemployment capacity utilization and that doesn't mean it's wrong for your theory but if your theory is different it's your responsibility to make sure the facts are consistent with the categories that you want and the understanding you want is that point clear? so I have now a measure of capacity utilization which anybody can do by the way all you need is real output and real capital stock to create such measure so here is the estimated normal capacity capital stock ratio the ratio of dead to living labor in the sense of Marx or the maximum rate of profit in the sense of Schroffa for the whole post-war period and you see that it moves in a pretty steady way downward this is a rising organic composition of capital in the sense of Marx and it comes, it's steady because it's a million little firms all making individual local decisions so there's no grand story of this it comes technical change this is technical change comes slowly and steadily of course there are little fluctuations but it comes fairly steadily now the profit to wage ratio this is what the rate of surplus value you can see in the post-war period in the golden age of labor from 1947 to about 1980 the profit-wage ratio is falling the rate of exploitation is falling in the sense of Marx and we know why that is there's no secret, many people have mentioned unions are strong welfare state is making sure that unemployment doesn't get too low making sure that you are unemployed there are payments that will keep you on unemployment insurance and welfare payments that keep you from suffering too much so that gives you power in the bargaining, right? so Friedman is right, this is where the state intervenes to help labor and this causes the profit-wage ratio or the rate of surplus value to fall and then the profit rate in that period is falling also this is the profit rate adjusted for capacity utilization it's not a smooth rate it's not just the profit-wage ratio I could I could smooth it also but I chose not to do that so this is the normal capacity profit rate this is the profit rate that Marx is talking about or Smith is talking about not the fluctuations but the central tendency from the essential movements of technical change and structural this is the structural element as opposed to the capacity utilization conjunctural element do you understand that? so we see here a falling rate of profit very steadily a falling rate of surplus value a falling profit share and a steadily falling ratio of the maximum profit rate or the debt to living labor equivalent here but notice what happens here this is the period where Reagan and Thatcher in England smashed unions cut back on their welfare state and literally weakened workers I saw you before the wage share curve shifts down in this period workers are weakened at any unemployment rate they have less power to have wage increases and you get the wage share the profit share then becomes a rising one Reagan restored the profitability of capital this is the age of capital if this is the golden age of labor capital neoliberalism and what it does is it stabilizes the profit rate it doesn't make the profit rate rise it eliminates the steady downward movement of a falling rate of profit it reverses it because of course the rate the profit share is a socially determined variable it depends on the balance of power between capital and labor that's not a new argument but the data makes that pretty clear and you can see that so you get this is the max bias technical change which the data finds this is the profit share a profit wage ratio which we see clearly goes up and this is the profit rate that gets stabilized because the wage ratio is going up but the maximum profit rate is going down so the actual profit rate is roughly stabilized a normal profit rate yes I understand is your understanding of the different from the latest max bias technical change is there any differences between I don't remember in this level of detail but I think they don't adjust for capacity utilization if I remember correctly but this is very important for me because if you're talking about the Vietnam War boom and you forget that then you think that there's just a flat profit rate and then it falls and this is something I've done I've mentioned to lots of people another person who measures profitability doesn't adjust for capacity utilization and I don't understand why not admittedly you need data for it but I have a technique for doing that people just take it for granted that the profit rate has what it is is what it is but that means that you don't believe in effective demand because the whole point of effective demand is to raise capacity utilization that's the point stimulate the economy so let me just move on because I don't want to run out of time here so this is the profit rate now without capacity utilization adjustment this is the observed profit rate and you see what happens if you don't adjust for it then you say well it went down then it went up then it went down well yes that's quite true but it went up because of an intervention by the state to cause the capacity utilization rate to rise the trend was actually falling throughout but the state had a big impact on the level but that same capacity utilization impact is not permanent because if you cause capacity utilization to rise firms increase capacity and they bring it down that's their job so they in fact bring it down to the trend the trend dominates in the slower process not the longer run when we're all dead but a slower process and this is not that long by the way we saw that before you see these trends are what 50 60 let's say 59 to 69 so 10 years 12 years whatever okay everybody with me here now here is the actual profit rate but this is the profit rate that would have happened if Reagan had not successfully shift the balance of power between the paper I mean he didn't do it himself they did it but he represented them so this is what the profit rate would have been like if the profit share had continued to fall and this is what it was so they actually effectively stabilized profitability so when you talk about that period astonishes me that people don't talk about the key variable which is profitability that's what they care about and they're clear about this pre-tax post-tax is what Trump is going to do that's the other story now here's the other part of the story I said that the rate of accumulation depends crucially on the rate of growth of normal output depends crucially on the normal let me just do output on the profit rate minus the interest rate plus all these other fluctuations right and we've talked about the profit rate so far normal profit rate capacity utilization so on but now the interest rate because obviously causing the profit rate to stabilize will prevent the falling profit rate but it doesn't cause a boom but lowering the interest rate now that's something that capitalism has never done on a scale like this so this is the history of the interest rate here's the interest rate and you notice as the price level goes up the interest rate goes up which is one of the expectations that I have from the argument that the interest rate is determined by competition and that goes up until you get this period here which is called the so-called Volcker shock Volcker was given inflation is going out of control here and Volcker was given the authority to go ahead as head of the Federal Reserve to shock the economy and the way the Federal Reserve has a shock on the economy is to raise interest rates because that causes investment to fall for just that reason and makes credit fall because people can't borrow with these high interest rates so demand falls from the investment side consumer spending, consumer borrowing side and the Volcker shock but the Volcker shock only takes it up to here and many Keynesians say oh everything was changed because Volcker did it all absolutely false the interest rate was rising long before Volcker which they forget because the price level was rising Volcker caused an acceleration to the rise but then after Volcker the interest rate was lowered down to in this graph this is 2007 2008 but it went to almost 0% afterwards so this was another policy thing that makes perfect sense for restoring accumulation and restoring the balance of power you weaken labor and you raise profitability that's the austerity part and you lower interest rates to stimulate the economy what do you mean by that? you restore profitability doubly because the other side of profitability the negative part of it is lowered and so therefore you have a higher net rate of return so I don't know whether it is true that these folks read Keynes or Marx but they certainly act as if they did because they understand the real process and that's not surprising Keynes and Marx are talking about actual capitalism not an ideal DSGE model or anything like that they're talking about matters to capitalism and this is what matters it's fundamental so this is the profit rate of enterprise this is the rate of profit minus the interest rate so this thing here r-i and you can see how I have an adjustable capacity utilization so here's the boom Vietnam war boom it is a crisis period of the stagnation crisis and you see what happens essentially negative at the end of that crisis and this is a very serious crisis banking failures, business failures people were worried that this was a great depression the state had to step in to protect banks protect businesses just as it did in 2008 and then you get the recovery where the profit rate is stable but the interest rate is lowering so the net profit rate is rising sharply beginning in the Reagan years and that was the cause of the rise in employment and growth in that period and one thing we know the growth rate rose, unemployment rate fell workers were persuaded that this Reagan had actually saved them and he did save them he saved them by reducing unemployment and giving them jobs at lower wages but look if you're unemployed the higher wage doesn't do you any good right so that's an important factor and then of course we get the crisis again 2008 and that's what I want to talk about comes from some of the consequences of this this is another way of looking at the wage share thing here is the hourly productivity is the dark line and the lighter line is the wage and you see that the two move together some rough correspondence but the wage is moving rising more slowly than productivity so even here at least in this period they're moving together and then more slowly but here you see the wage falling much more slowly than productivity much more slowly and this is the effect of attacking unions and attacking the welfare state it slowed down the growth of wages didn't prevent it from rising, slowed it down so here's another look at the data from a different point of view which is income by distribution in this period here you have an income distribution the top and the bottom parts the bottom 90% which is a green line and the top 1% are growing at not roughly the same rate but pretty close to each other in fact the bottom is growing a little bit faster and then comes the Reagan era the top goes like this and the bottom 90% as income which is essentially stagnant 90% and that's the period of the great stagnation of incomes of workers that's not what we were looking at yes okay I thought I said that but let me go back this is the competitive interest rate and this is when Volcker intervenes away from that because the competitive rate as you see is moving up with inflation then Volcker moves to raise it higher than that which he can do by putting breaks on credit and usual things that central banks can do and then after that they changed entirely to move it away from its competitive level which would have followed up here down to here so that's the great intervention of central bank policy in the post-war period in all countries of the world everybody began to do the thing this was to stimulate capitalism in a period where before it had become stagnant and this was supposed to give it the stimulus it doesn't follow that it always was effective in restoring growth but yeah do you have a separate view on just the profit-making by MSQP disease? no I do well I didn't show it in the book I mean when I hit a thousand pages in the book these graphs are among them but you can create it from the data it's there so it's in the book can I have your choice I guess this was also appreciated by some guy from the management school he wrote a very short paper when he was looking at the real cause of what he calls financial crisis modern background mutual funds hedge funds hedge funds and mutual funds actually they just to pay money out of out of the market and that left the investment banks but he also talks about something we actually mentioned he actually says I guess during the 80s he was saying that because of this mutual funds, hedge funds in the modern world the existing banks became less competitive and they started ways of starting other ways of doing business how does that fit I don't address that here because my purpose is to show the broad movements not necessarily to trace every step in a little bit but the key point is here this movement in the interest rate may well have local determinants of the sort you're talking about but we know that the state was very much involved I don't explain the fluctuations and all that you can do that but keep in mind this problem I always say people look locally at things and they attribute all the determination to the local one whatever it is because they have no other theory so it's not obvious that that determination is central it's always around a moving here you can see this very clearly it is central because lots of local fluctuations that may be explained by other concrete factors including business cycles and foreign events but this movement in every capitalist country in the world I think can only be explained by central bank policy that's what they were doing so in that sense they were really pushing the interest rate down and the other parts are reactions and adjustments and maybe some autonomous ones but I don't think they're decisive and many times people always say well this is a local thing you know these bad guys in Florida and if I do with that the world would be fine it's just not true I want to make sure I don't run out of time so let me here's a very interesting thing remember I showed you in the beginning that if you look at prices over the long run you see that beginning in 1790 they go way way way up and down and by 1940 which is a long way from 1790 the price level is no higher than it was in 1790 just astonishing then after 1940 the price level goes out of sight well one of the things that happens after 1940 is precisely the amount of new purchasing power which is pumped into an economy with fiat money you can do it with fiat money because you can print it and fiat money is like bitcoin only you can create it as you want so it's a double thing and basically the state is able to do that private credit also gets because the state is able to support expansion of private credit so this is a measure of the total amount of private and state bank credit not debt credit per employee so credit is new in every period and this is astonishing this is credit in every period per employee if you want to look in one place first this is why inflation is what it is it's this it's the increase of purchasing power per person in my chapter on inflation I'd build this data into a more somewhat more general model but it's very important so here's something we know look what happens in the crisis in the neoliberal era these are the wages people working in the credit sector these are the wages people working in the insurance sector these are the wages of people working in other finance basically investment banking and you see the wages are moving roughly together in fact the investment banking in this sector's wages are lower than the wages in insurance and banking but then in this period of the 1980s you see this is where the bonuses and all the huge pumping up of the credit of the stock market and the derivatives and all that and you look at the difference in the income this is financialization right here expressed in terms of the wages of people who work in those sectors as opposed to the profits of that sector okay I've done this already so there are many other things I could do but I want to make sure that I try to explain again what the purpose of this exercises the purpose is to show that the same framework that can explain growth can explain crisis not independently of what happened socially and historically the drop in the interest rate is institutional the class struggle is intrinsically institutional so that's always there always but they operate through some particular deep variables and we have to understand the deep variables effective demand equalization of profit rates the movements of the stock market I haven't even talked about the bond market I mentioned the interest rate only in the book and I haven't mentioned at all exchange rates let me just briefly say if you think what an exchange rate is an exchange rate is the ratio of one currency to another so the exchange rate is let's say E is yen per dollar that's an exchange rate the theory of the exchange rate and I want to argue in the book that the same principle operates to determine the theory of interest rates because if you take a real exchange rate that's the price of US goods times the exchange rate over the price of Japanese goods let's say J for Japanese so US goods and this is yen per dollar and this is yen so this exchange rate is now has no units that's a real exchange rate but if you think about it what is a real exchange rate it is really a relative price in common currency when I look at the price of corn and steel in the United States I take them in dollars or dollars in common currency but if I look at the price of steel in the United States and steel in Japan then I have to use the exchange rate to make them common currency so a real exchange rate is actually a relative price of two different goods the goods in the basket of the US price index and the goods in the basket of the Japanese price index and what I show of production of these goods I mean you can write that out I don't know how to do this without making it more complicated let me not say that so these are prices of goods and prices of goods depend on their cost structure and the profitability so we can look at these and I show that you can translate this into a statement about the determinants of the real exchange rate in terms of productivity change wages real determinants and that this explains the actual movements of real exchange rates in the US and Japan for instance in many different countries that's an illustration but in many different countries because they are relative prices and relative prices are determined by relative costs of production and profitability wages and so on and the cost and the cost and the equalization of profit rates relative prices of production when you do that it requires some development what you find is that you find that you are in the same domain as relative prices within the country allowing for the exchange rate and you can show the movements of the real exchange rate over time are regulated by the underlying real costs the cost of production in the US and Japan let's say data on that, I actually use real wages and productivity, real unit labor costs. And even that works extremely well. So I can explain movements of the exchange rate. That has an implication, which is that exchange rates are not determined, real exchange rates are not determined by policy. They're determined by competitiveness. And that means that when I look at countries that are more competitive, they're lower unit labor costs or higher productivity, I would expect them to have a better balance of trade because people are going to buy from them. They're cheaper in real terms. And so China and before that Korea and before that Japan and before that Germany had balance of trade surpluses because they were more competitive. But if you're a neoclassical economist like Krugman, then you would have to say that China and Japan and Germany were cheating. They were lowering their exchange rate in some false way because neoclassical theory says that if you let countries compete who are unequal, the real exchange rate will move to make their cost structure the same. That's called comparative cost, the comparative cost hypothesis. So Krugman is actually consistent to say, look, I accept the fundamental neoclassical theory and since the US has a balance of trade deficit, we're not doing it, we wouldn't do that. So therefore it's got to be the other guy. And that follows logically. Estimates of the equilibrium exchange rate are based on the assumption that the exchange rate would be such that the trade would be balanced. So if this trade is in balance, they say you have a disequilibrium exchange rate. But from my point of view, this is an equilibrium exchange rate when the real exchange rate is determined by cost. And I expect to see persistent differences in trade balances. And I show in the book that they are persistent. They're persistent over the whole period for which we have data. And they're related to cost. China wins because its costs are lower. Bangladesh wins its costs are lower. Japan and before that, Germany and Korea. And these are due to the same principles that you have within a country. If the costs are lower in New Jersey, then I buy from New Jersey. So New York runs at balance of trade deficit because I have more goods from New Jersey than I buy in New York. And New York costs are higher, adjusting for transportation and taxes. Now you can protect New York. You can have tariffs. You can prevent me from going across the border in Massachusetts. New Hampshire has next door to Massachusetts. New Hampshire has liquor stores which are run by the states. The liquor is really cheap. So people go across the border, fill up their car, and come across. And then Massachusetts started complaining and saying, that's not fair. New Hampshire's saying, well, it's competition. I mean, we're allowed to be cheap. We're not private. So we don't have to pump up the price. So then Massachusetts started putting people on the border to prevent you from smuggling goods back, even though in the United States you're legally allowed to bring goods across the border. And they were starting charging you tariffs and all that. And a little war took place in there. But that's the balance of trade issue. It's cheaper in New Hampshire. So of course you're going to buy in New Hampshire if you can, if the costs are not too great. And that allows us to unify the theory of international trade, the theory of national competition, exchange rates, interest rates, stock market, effective demand in the same framework. Now it's not a simple thing. You don't just say profitability and it just falls into place. You have to be concrete. You have to develop the actual mechanism. So I urge you to think about this as a way to do your own work, not just to say that was interesting. Now let me go back to microeconomics or agent base. No, go back to a DSG model. Yeah, you should learn how to do that. But if you're going to think about how to analyze the world, then consider that there's another way, not just neoclassical, not just post-Keynesian, which is also general, but a classical Keynesian framework. So thank you.