Home > Uncategorized > The relationship of the real investment led economy perspective to existing views

The relationship of the real investment led economy perspective to existing views

from Michael Joffe

This perspective contrasts with standard neoclassical theory in several respects. That theory puts forward models relating to the decision making of (potential) workers, and of firms – respectively the supply of and the demand for labor. Workers choose whether or not to accept employment, based on a comparison of the offered wage with their reservation wage. Firms’ decision making is seen as a comparison between employing one more or one fewer worker with the difference this would make to production – respectively marginal cost and marginal benefit – given that the firm already exists, and has an established production system with premises, equipment, etc. Neoclassical theory implies that the forces of demand and supply rapidly bring about an equilibrium in which there is neither excess demand for labor, nor excess supply. 

The real investment led perspective holds that it is true that a process of adjustment does occur (see Section 5), but the timescale is far slower than neoclassical theory would imply. It involves investment decision making that depends on the economic environment, including likely future demand – the micro (or meso) analog of Keynesian aggregate demand. In addition, the bulk nature of investment implies that the decision making is “lumpy”, rather than the “smooth” process implied by the theory – although very small firms’ decisions may approximate to the notion of adding or removing an individual marginal worker. Finally, it is an open question whether investment is best seen as part of an adjustment process leading towards equilibrium, or as a disequilibrium process of creative destruction – a topic that is beyond the scope of the present paper.

In the neoclassical perspective, wages are – or “should be” – flexible, and the labor market “should” clear. The observation that persistent unemployment is quite frequently observed has led to the modification that (nominal) wages are assumed to be sticky downwards. This asymmetry can be compared with the asymmetry in the real investment led economy perspective, which is because some investments do not promise to be profitable even with low wages, so that a shortage of jobs does not lead to a fall in the wage level; in contrast, a shortage of workers does raise wages (section 5).

As its name suggests, the real investment led economy perspective places investment at the center of the economy. A large proportion of economic activity is the result of previous investments by firms. This means that the investment decision, the driving force, is strongly endogenous to this system in a causal sense. This contrasts with the view that attributes labor market phenomena to shocks to e.g. demand or productivity.

The familiar concept of rent attributable to employer-employee matches, divided between the two parties, is represented here by (a) a contribution to firm profitability, and (b) comparison with the worker’s outside options, i.e. when unemployed, inactive or self-employed, or the wage in a previous job (for matches following in-job search), as appropriate.

In the literature, some emphasis has been placed on the distinction between new jobs and existing or continuing jobs. The proposed perspective suggests the need to further distinguish between jobs that are newly-created (strategic) and newly-negotiated (tactical – e.g. new matches). It explains why wages in new matches (tactical) respond to the current unemployment level, whereas those in existing jobs do not (Pissarides, 2009; Koenig et al., 2016) – they were already set during an earlier strategic decision.

The real investment led economy view takes labor supply as given. It does not address participation rates, i.e. flows between unemployment and inactivity, or in-job search as contrasted with the job search of unemployed potential workers. For these aspects of the labor market, a complementary approach such as a search-and-matching model is required. This does have consequences for real-economy investment, via the economic environment. For example, if previously inactive workers become available for work (“unemployed”), e.g. as a result of a policy intervention, or if largescale immigration suddenly occurs, firms can take this into account in their investment decision making for the future.

The real investment led economy view has little to say about how jobs come to an end for an individual worker. This is because the starting point in that situation is an employee who is already in a relationship with an employer, implying a much more symmetrical situation: either party can bring the arrangement to an end. The employee can leave for personal reasons or to move to a better job, or s/he can be sacked for low productivity, indiscipline, etc. But it is highly relevant to larger scale job losses, as discussed in the next section.

Michael Joffe, “The creation of jobs”,
 real-world economics review, issue no. 83, 20 March 2018, pp. 65-86, http://www.paecon.net/PAEReview/issue83/Joffe83.pdf

  1. Prof James Beckman, Germany
    April 15, 2018 at 9:41 am

    Michael, a fine analysis. In the real German economy, employees at any level are evenually transferred, retired or let go with benefits. Most German managers are effectively retired in their 50’s because they lost out on promotion. Many of these go to consulting or teaching.

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