Long run demand effects

23 April, 2016 at 12:44 | Posted in Economics | 1 Comment

In the standard mainstream economic analysis — take a quick look in e.g. Mankiw’s or Krugman’s textbooks — 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, expansionary economic policies actually may 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?

60274818There 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 on the direction of causality). Given this, however, most studies on the country level do confirm that the Verdoorn law holds.

Conclusion: demand policy measures may have long run effects.

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  1. And crucially a high wage policy induces more investment in automation and greater productivity gains, so a full employment, tight labour market is very good too, with incomes policy to control inflation.


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