Vertical models for economic development and cycles

Abstract

In the first part of this article an outline is given of the author’s new theory [1] of economic development and cycles which differs in some important aspects from recent theories on this subject. A simplified “vertical model” is established to show the relationships essential for a proper understanding of economic development and cycles. This model is so simple that an econometric model about measurable magnitudes can probably be derived from it. The hypotheses underlying the new theory—the “economic model”—particularly take into account the fact that in an industrial economy the output quantityper time unit of a product depends on the existing quantities of capital goods (not per time unit), whose outputs (increase of existing quantities)per time unit are in their turn dependent upon the existing quantities of some capital goods “of second order”, etc. Hence, the production relationships become differential equations (or, when “time lags” are considered, difference equations). Such a model shows the possibility of a state ofdepression which is different from a set-back in development, and shows that fluctuations between states of full employment and of depression are probable. This would not be true in the case of a handicraft economy with only one “order of capital goods”, or none at all, where there is no depression in the modern sense nor such cycles as have been observed in Europe from about 1810 (starting later in the USA) up to World War II. In such handicraft economics,Say’s Law is valid, i. e. any production produces its own required demand [2]; low development and unemployment can only be caused by a lack of goods but not, as in modern depressions, by their abundance. The author’s theory shows how in an industrial economy with more than one order of capital goods—e. g., capital for final production, for several orders of intermediate production, and primary resources as capital goods of n-th order—not only a lack of consumption goods, but also their abundance causes unemployment. This fact is explained without the assumptions on monetary efficacy and human behavior, as made byKeynes and many “modern” theorists; nor do time lags [3] and imperfect adjustment play any role in this explanation. Of course, an abundance of all goods would make the satiating economy of Cockaigne possible. In brief, the theory suggests this: The abundance which causes need is a relative one, namely the excess of consumption goods over an amount proportionate to the equipment with productive capital goods. This excess involves poor profitability of the final production, which in general induces economists to expect the profitability of the investment in capital goods of higher order to be similarly poor. Hence, the above-mentioned relative excess brings about a low utilization of capital goods of all orders as well as unemployment. To be sure, “excess of consumption goods relative to productive capital” is tantamount to “lack of the latter relative to the former”. However, this lack remains hidden, since the expected poor profitability of productive capital goods and their consequent low utilization raises the (fallacious) impression of an abundance of capital goods of a higher order, and thus of all goods, which apparent abundance paradoxically engenders scarcity instead of satiation [4]. In addition, the theory is also capable of describing and explaining many important features of economic development or contraction—the latter being essentially different from depression—of both highly developed and underdeveloped economies.