Bernie Sanders and the Verdoorn law

27 February, 2016 at 16:54 | Posted in Economics | 12 Comments

Reading the different reactions, critiques and ‘analyses’ of Gerald Friedman’s calculations on the long term effects of implementing the Sanders’ program, it seem to me that what it basically burns down to is if the Verdoorn law is operative or not.

Estimating the impact of Sanders’ program Friedman writes (p. 13):

Higher demand for labor is also associated with an increase in labor productivity and this accounts for about half of the increase in economic growth under the Sanders program.

Obviously, that’s a view that  Christina Romer and David Romer (p. 8) don’t share:

Friedman … argues that as demand expansion raised output, endogenous productivity growth … would raise productive capacity by enough to prevent it from constraining output … The evidence that productivity growth would surge as a result of a demand-driven boom is weak. The fact that there is a correlation between output growth and productivity growth is not surprising. Periods of rapid productivity growth, such as the 1990s, are naturally also periods of rapid output growth. But this does not tell us that an extended period of rapid output growth resulting from demand stimulus would cause sustained high productivity growth …

In the standard mainstream economic analysis, a demand expansion may very well raise measured productivity — in the short run. But in the long run, expansionary demand policy measures cannot lead to sustained higher productivity and output levels.

verdoornIn some non-standard heterodox analyses, however, labour productivity growth is often described as a function of output growth. The rate of technical progress varies directly with the rate of growth according to the Verdoorn law. Growth and productivity is in this view highly demand-determined not only in the short run but also in the long run.

Given that the Verdoorn law is operative, Sanders’ policy could actually lead to increases in productivity and growth. Living in a world permeated by genuine Keynes-type uncertainty, we can, of course, not with any greater precision forecast how great those effects would be.

So, the nodal point is — has the Verdoorn Law been validated or not in empirical studies?

There have been hundreds of studies that have tried to answer that question, and as could be imagined, the answers differ. The law has been investigated with different econometric methods (time-series, IV, OLS, ECM, cointegration, etc.). The statistical and econometric problems are enormous (especially when it comes to the question, highlighted by Romer & Romer, on the direction of causality). Given this, however, most studies on the country level do confirm that the Verdoorn law holds — United States included. Most of the studies are for the period before the subprime crisis of 2006/2007, but if anything, it is more in line with Friedman than Romer & Romer.

Oh, dear.

12 Comments »

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  1. What about the points (part 1) discussing a GDP stimulus being 1 off vs repeated year on year? This would appear to be a problem without getting into the realism of the model being used.

  2. Which are these “most studies” that obviously Romer and Romer neglect?

  3. Going beyond sitcom economics
    Comment on Lars Syll on ‘Bernie Sanders and the Verdoorn law’
    .
    Both, the neoclassical and the Keynesian approach are known to be worthless because their respective foundational premises are false. Proofs have been given elsewhere.*
    .
    Because neither side argues within a formally and empirically consistent theoretical framework, the Friedman—RomerRomer debate is sitcom economics.
    .
    What is obviously needed for the evaluation of any political program is the correct employment theory. The general public tends to think that economists have developed this theory over the last centuries. But this has not been the case.
    .
    To cut a meticulous formal derivation short, the most elementary version of the correct employment equation is given here:

    .
    From this equation follows:
    (i) An increase of the expenditure ratio rhoE leads to higher employment (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction/debt repayment of private households.
    (ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
    (iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.
    .
    The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export. The equation contains only measurable variables and is testable, so there is no need for the usual clueless filibuster.
    .
    Item (i) and (ii) is familiar since Keynes. What is missing in the Keynesian employment multiplier, though, is the ratio rhoF as defined in (iii). This variable embodies the price mechanism. It works such that overall employment INCREASES if the average wage rate W increases relative to average price P and productivity R.
    .
    The employment equation says that an increase of investment expenditure or deficit spending increases employment. The multiplier, though, is different from Keynes’s flawed multiplier (2012). The crucial difference consists in rhoF.
    .
    Now, the fact of the matter is, that an increase of productivity COUNTERACTS the expansive effect of investment or deficit spending. That is to say, if a Verdoorn effect indeed exists, which is an entirely different question, then it keeps employment roughly at the current level (2011). So, the Verdoorn effect does not help, but hinders.
    .
    To increase overall employment requires an increase of rhoF and this means that the expansion must be wage driven, i.e., the increase of the wage rate must be such that it overcompensates the retrograde effects of productivity and price increases.
    .
    To be sure, the correct employment theory is far beyond the horizon of Friedman, RomerRomer and the blathering rest of sitcom economists.
    .
    Egmont Kakarot-Handtke
    .
    References
    Kakarot-Handtke, E. (2011). Increasing Returns and Stability. SSRN Working Paper
    Series, 1921267: 1–19. URL http://ssrn.com/abstract=1921267.
    Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous
    Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
    http://ssrn.com/abstract=2130421.
    .
    * See blog http://axecorg.blogspot.de/ and working papers http://www.axec.org/

  4. Looking at experiences of very high rates of economic growth over long time periods, such as in Germany and Japan before 1980, it is hard to believe that this was not heavily demand driven. Very large increases in income and demand were driving investment and productivity increases – this has been very well documented by historians.

    • My own experience is that such causality is extremely difficult to tease out from the data. Do you mind providing any sources where this is “very well documented by historians”?

    • Nanikore

      As I said in the post above: “The [employment] equation contains only measurable variables and is testable, so there is no need for the usual clueless filibuster.”

      If historians have the periods well documented, all that has to be done is to put the data into the employment equation and to check whether the employment figure comes out correctly. See also the post ‘Prediction does not work? Try retrodiction first’ http://axecorg.blogspot.de/2015/11/prediction-does-not-work-try.html

      This is how economics as an empirical science works.

      Egmont Kakarot-Handtke

      • Sorry Egmont. But that is not how history or historians work. I will give you another example. Please put the causes of WWII (very well documented) into an equation and test it.

        The point is that there are too many things in social systems and in the real world in general in which mathematical and quantitative modelling is not an appropriate means of analysis.

    • Nanikore
      .
      It is pretty obvious that you have no idea how science works.
      .
      (i) The first thing to know is that genuine scientists do not predict at all, see ‘Scientists do not predict’
      http://axecorg.blogspot.de/2016/02/scientists-do-not-predict.html
      Therefore, your WWII argument is beyond silly.
      .
      (ii) Historians have no say in science because they cannot rise above the level of storytelling: “That is why Descartes said that history was not a science — because there were no general laws which could be applied to history.” (Berlin, 2002, p. 76)
      .
      (iii) The fact that scientists do not predict the next political or natural disaster is perfectly compatible with making a projection under the IMPLICIT condition that no disaster happens. Every TV watcher understands that the weather forecast for the weekend holds under the IMPLICIT condition that the world is not blown up in the meantime.
      .
      (iv) That the world is complex is not such a new insight as you seem to think, and even the dullest econ101 student knows from J. S. Mill how to deal with it: “Since, therefore, it is vain to hope that truth can be arrived at, either in Political Economy or in any other department of the social science, while we look at the facts in the concrete, clothed in all the complexity with which nature has surrounded them, and endeavour to elicit a general law by a process of induction from a comparison of details; there remains no other method than the à priori one, or that of ‘abstract speculation’.” (1874, V.55)
      .
      (v) If you had done your homework you would also know this from Walras: “Any order of phenomena, however complicated, may be studied scientifically provided the rule of proceeding from the simple to the complex is always observed.” (2010, p. 211)
      .
      (vi) The major problem of economics is not the complexity of the world but the stupidity of economists who can until this day not tell the difference between income and profit: “We know from the history of science that entrenched classificatory schemes and misleading descriptive vocabularies have impeded scientific advance as much or more than the complexities and observational inaccessibility of the subject matter.” (Rosenberg, 1980, p. 114) *
      .
      (vii) Is it not curious that economists are deeply convinced that ‘I know that I know nothing’ is a statement humanity needs urgently for enlightenment and must therefore be repeated ad nauseam?
      .
      Egmont Kakarot-Handtke
      .
      References
      Berlin, I. (2002). Freedom and Its Betrayal. London: Chatto Windus.
      Mill, J. S. (1874). Essays on Some Unsettled Questions of Political Economy. On the Definition of Political Economy; and on the Method of Investigation Proper To It. Library of Economics and Liberty. URL http://www.econlib.org/library/
      Mill/mlUQP5.html#EssayV.OntheDefinitionofPoliticalEconomy.
      Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.
      Walras, L. (2010). Elements of Pure Economics. London, New York, NY: Routledge.

      * See ‘How the intelligent non-economist can refute every economist hands down’
      http://axecorg.blogspot.de/2015/12/how-intelligent-non-economist-can.html

  5. What Romer is saying reminds me of Prescott saying that it has been “scientifically proven that monetary policy has no impact on output”. Why is it true? Because Model says so.

  6. […] private sector investment propelling productivity increases per Verdoorn’s Law (see Freidman and Lars Syll responses on this point).  Other Sanders programs will rapidly drive up the U.S. labor force […]

  7. […] private sector investment propelling productivity increases per Verdoorn’s Law (see Freidman and Lars Syll responses on this point). Other Sanders programs will rapidly drive up the U.S. labor force […]

  8. […] private sector investment propelling productivity increases per Verdoorn’s Law (see Freidman and Lars Syll responses on this point). Other Sanders programs will rapidly drive up the U.S. labor force […]


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