Income Distribution and Business Cycles

Abstract

Despite a century of work, significant disagreement remains on what causes business cycles. A literature survey of business cycle theory and empirical research demonstrates how extensive the work is in this field (see Zarnowitz for an overview of business cycles). Not only is there a lack of consensus across schools of thought, but substantial theoretical differences exist within the Neoclassical school. Controversy persists over whether cycles are created endogenously or exogenously, whether the real or financial sector is more important, and whether the economy is fundamentally stable or unstable. However, progressive economists agree that profits, profit rates, the price-cost cycle, and the functional distribution of income are central in generating cycles. The purpose of this study is to argue for the importance of income distribution in generating capitalist cycles because of its affect on profitability and investment. Specifically, the objectives are two-fold: (1) To explain how income distribution is determined and how changes in income distribution induce cycles, and (2) To measure income distribution and to determine whether there is an empirical connection between cycles and income distribution. This paper's specific contributions are that it synthesizes heterodox cycle theory, clarifies the specific and critical role played by income distribution in perpetuating cycles, and sets forth a multidimensional, environmental context which determines cycles and trends in income distribution. This effort should prove to be of interest and importance to heterodox economists. First, cycles in production affect employment and income levels of many people who are of modest means and depend upon the business community for their living standard. Understanding cycles is one step toward creating instrumental change. Second, the following theory incorporates a number of important principles: endogenously created outcomes, interdependent variables, power differences between corporations and labor, importance of property rights and status, and a central role for institutions and technology. And finally, this work attempts to forge some convergence in heterodox thought on business cycles. This is one area where progressive economists can find common ground.(1) Literature Survey Heterodox economic schools emphasize the central role of profits in generating cycles. For Veblen, profit considerations dominate business decision-making. When selling prices are above costs, production increases and collateral values rise along with the use of credit; the reverse causes debt liquidation and a downturn (Veblen, 1904, chap. 7). Mitchell (1951 and 1959) is known for his elaborate statistical analysis of cycles and the importance he places on profit pursuits creating each of the cycle phases. Heilbroner and Gordon argue that cycles are functions of the quantity of investment opportunities and the given social setting. This setting depends on the current state of the relationship between business and labor, business and government, and business and the public. However, there is no endogenous explanation for when social settings change (Heilbroner, 1988, pp. 73-74; Gordon, 1978). Some economists argue that income distribution affects economic stability or growth (Peach, 1987; Jarsulic, 1988; Myrdal, 1962; Hahnel and Sherman, 1982; Sherman, 1991; Kalecki, 1971; and Pulling, 1978) while others believe that income distribution is important, but not causal (Haslag and Fomby, 1988 and Goldstein, 1986). Peach writes that income is distributed according to the forms of institutional power arrangements in society and that there is no tradeoff between growth and increased income equality. After reviewing the empirical work on income shares and crises, Jarsulic constructs a dynamic model where expectations and nonexpectational factors play an important role in affecting stability. He concludes that economists should explicitly consider how income shares are determined and that this could provide further insight into the analysis of financial instability (Jarsulic 1988, pp. …