Welcome back to Economic growth. This video explains the Post-Keynesian growth theory. You will learn that more wage income and less capital income can be just as good for growth as more capital income and less wage income. But a mechanism of how they lead to growth is different than through the social cohesion mechanism of social economics. It is a bit technical, but I will take you through it, step by step. Why would you take this effort? Because it will give you economic arguments in favor of redistribution in your discussions with economists. You will be able to argue almost just as eloquently as Keynes himself did. The basic insight from Post-Keysenian Economic Growth Theory, is that growth is demand-led, and not so much determined by the supply side of the economy. For understanding this, we need to go back to the basics of macro economics, namely, the aggregate demand equation. In short, the macro economic equation. Aggregate demand, AD = C, consumption,+ I, investment + G, government expenditure + EX, exports, and- IM, imports. I'm sure you will remember this one. Actually, it's so important that it comes back several times. If we want to stimulate AD to get more growth, we can do it through any of its components. But let's pick consumption, because it's often the biggest one. To explain how consumption can stimulate AD, we will have to go back to a few other familiar equations. As you may remember disposable income Yd is income Y- taxes T. Consumption is made up of autonomous consumption C* + disposable income, Yd multiplied by the propensity to consume, small c. Do you remember these ones? If you don't, you can look it up in week six. Let us now plug in numbers, which is simply billions of units of money, such as euro or dollar or Chinese yuan. Assume the following four numbers for these variables. Income Y is 1,500. Tax T is 20%. Autonomous consumption C* is 140. Propensity to consume, small c is 0.8. This means, that we can calculate the amount of taxes and disposable income and with this the size of consumption T is 20% x income of 1500. That makes 300 right? So, disposable income Yd is 1500- 300 taxes = 1200. Next we can calculate is size of consumption in the economy. C* is autonomous consumption worth 140. Plus small c x disposal income. That is 0.8 x 1200. Are you still following me? I'm sure you do. I just want to take you through the steps. Small c is the propensity to consume, and above I assumed it was 0.8. And we just calculated the disposal income Yd is 1200. So now we can calculate consumption in this economy. 140 + 0.8 x 1200 = 140 + 960, together, it's 1100, so the value of consumption is 1100 billion. Are you still with me? Hey, you did a great job. You just did a few important macroeconomic calculations, well done. Consumption can be stimulated with lower taxes, so let's assume taxes go down to 18%. This means that t is 0.18 x 1500, which is 270. The new disposable income, Yd, will now be 1500- 270, that is, 1230. So, compared to the tax of 20% of before, people now have 30 year or more disposable income. But remember, part of disposable income is consume and part of it is safe. So we need to calculate how much will be spent on consumption. This we will call C2, the second consumption level after tax reduction. C2 is 140 as before + 0.8 times disposable income which is now 1230. This makes 140 + 984 which is together 1124. Remember the macro economic equation defining aggregate demand. Y is now increased with the extract consumption C which is 1124- 1100 is 24. In conclusion the tax reduction has stimulated aggregate demand through an increasing consumption. In turn the increase in AD increased GDP, and hence it creates economic growth, all according to Keynes. Now you are ready for the final step in the analysis. This is including the multiplier effect. Remember from week six that the multiplier increases the total effect of a stimulation to aggregate demand. Because of all kinds of indirect effects right. So AD was increased by 24 due to the tax reduction. This allows us to calculate the multiplier effect. Remember that the equation for the multiplier effect is the stimulus as an numerator, and 1- the propensity to consume in the denominator. This gives 24 in the numerator and (1-0.8) in the denominator. So 25 divided by 0.2, which is 120. Finally, this allows us to calculate the total economic growth effect of the tax reduction. The old income, Y, was 1500 billion, and if we add the multiplier effect of 120, we get 1620 billion. So, the new income, after the tax reduction policy is 1620 billion. Growth is the percentage change so (1620-1500)/1500 x 100%. This gives a growth rate of 7.5%. You are now ready to move to the post gains growth equation. This shows that growth is endogenous. It can come from labor income, which is largely consumed. Or it may come from capital income, which is largely invested. Any element of aggregate demand can stimulate growth. That is the post tension x-factor. Remember that savings equals investments, and that S, savings = Y- C. You may also remember that the richer you are, the more you save out of income. To simplify this a bit, we now assume that only capitalists save and workers spend all their income on consumption. As S savings comes entirely from capital income or rent, not from labor income. This leads to the following equation. I, investment = small s, propensity to save x R, rent or capital income. In order to get the post-Keynesian growth equation, we have to divide both sides of the equation by the size of the capital stock. Okay, this gives I over K = S x R over K, right? We divide investment by the capital stock, and we divide savings by the capital stock. Now remember that big R over big K is the same as small r, which is the profit rate. And big I over big K is small g, for the economic growth rate. This allows to finally write down the post Keynesian growth equation. g = sr. In other words, the economic growth rate is the propensity to save multiplied by the profit rate. And this is an endogenous growth equation because g and r are determined simultaneously in the economic process. The profit rate depends on capitalist income. The growth rate is the increasing total income of capitalist and workers. And what remains of income after capitalist got their profit is the wage income for the workers. Now we can distinguish between two different growth strategies. Profit led growth and wage-led growth. And countries can simply choose between the two. in the case of profit-led growth, we will see high capital income, which allows for high savings and hence high investment. But there will be low consumer demand due to low wages. So this will constrain growth. Indicates of wage lead growth, we see high consumer expenditures out of relatively high wage income of workers, but limited investment. Which will constrain growth. A solution to the problem of both strategies is the rest of the world, or RoW. Exports will increase consumption through the foreign demand for goods. And FDI, foreign direct investment will increase I, investment. The post Keynesian growth equation, as we have seen on a previous slide, is g = sr, which is the same as investment over K, capital stock. Here I write it out full. Also now on the previous slide the mysterious X factor is hated. It's not an addition valuable as was the case in social economics and institutional economics. But it refers to where growth begins. Mainly at the demand side of the economy, with the variables making up aggregate demand. Such as consumption, and investment and export. All being determined at the same time, which is called endogeneity. Are you curious about the size of the variable of the world champion of economic growth, China? Economic growth in China has been 10% for almost two decades. And this is made up of a rate of investment of 40% out of GDP, divided by a capital stock of 4 times GDP. The country overcomes the constraint to growth of low wages by exporting a lot and by receiving a lot of FDI from Western multinationals, such as Apple and Unilever, who benefit from the cheap labor in Chinese factories. This concludes the video on the post-Keynesian economics of growth. We have learned that growth starts from aggregate demand, either from wages, through consumption, or from profits, through investments. And that with growth, also profits and wages are determined at the same time. So that mysterious X factor stands for demand and endogenetiy through the math. I admit, it took quite a bit of equations and calculations, but I promise this was the most technical lecture of the course. So if you follow me all the way through, you are a real champion. If you're not sure you did, you can watch the video again. And there is also tutorial, and of course you have the course book you can read section 12.4 again. For now, I consider all of your champions, for having reached this far in the course, and getting the key point of how the famous economist John Menard Cain's understood economic growth. Not driven by the supply side, but by the demand side the economy. The next video will present the classical theory of growth without calculations.
