Understanding Economics over Millenniums: some concepts

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Most of us have been taught the history of economic progress with stories such as the consequences of the steam engine, or the formidable impact of railways. I remember of a teacher who used to explain the entire industrial revolution with the power loom. According to this Professor, the power loom generated needs for wool – hence sheep, hence the enclosures in Britain –, energy – hence, coal mining –, machines – hence iron and steel. Another fairy tale, still fashionable today, is the à la Colin Clark theory of the three economic sectors: primary, secondary and tertiary. According to this theory, economic development consists into the transition of labour from primary to secondary and then tertiary activities, a typical theory from an Australian economist who might have believed that economics started with British farmers and industrialists, and that the obvious scarcity of skilled labour in his country was a sign that the fate of economic progress entirely relied upon the development of the so called service sector. This was making a confusion between activities as seen when being exchanged in the market place, and real activities. Indeed the Australian natives had from their very beginning the allocation of work between the three sectors, and it would be hard to say what the proportion of hours devoted to each of them was. Simply consider the job of a hunter who had to make his weapons, shoot and carry his pray and, perhaps most important of all, paint a hunting scene on the wall of his cave. The confusion is made by 20th century economists, because they consider economic activities only when they appear as transactions in the market place, and when they are exchanged through an official pricing system. By official, I mean controlled by a political authority, i.e. a sovereign body whose legitimacy in validating the transactions relies in part on coercive power. But the market is not at all restricted to this. And economics is not even restricted to market economics. In actual fact, if one considers economics over centuries and millenniums, most transactions and prices are hidden.

In this paper, I will stand for two positions.

i. the so called secondary sector is the only sector we have to track in order to understand and foresee the direction of economic change,

ii. the development of this segment of the economy proceeds in steps related to the commonly used system for time measurement in society.

i. Economic progress is in fact machinery, automatism, replacing human labour, be it labour of the farmer or clerical work. The theory that the growth of the tertiary, i.e. the service sector, had finally to be faster than that of the secondary (i.e. broadly speaking, the extracting, manufacturing and construction industries), is based on false beginnings. This theory didn’t see that the faster growth of the service sector throughout most of the 20th century was not merely resulting from changes in activities, but mostly due to the statistical incidence of large amounts of the labour force entering the market place. A twofold incidence. a) The servant in the 19th century was not accounted for in the overall statistics of economics activities – as Xenophon in “The Oeconomicus” did not take slaves into account in Socrates description of the economic sphere, because slaves were not citizens in the ancient Greece –. When the 19th century servant became a wage earner in a factory, some suddenly saw this segment growing, but not the tertiary decreasing (some economists tell you that all growth in the secondary sector is at the expense of the primary sector, even if the person concerned was in fact previously employed as a servant, whether at the farm or at a merchant shop). Now, this wage earner – or his descendant – leaves his job in the manufacturing industry and goes to the tertiary, as a hairdresser, waiter, taxi driver, or even, as an accountant or teacher, to what was originally the first job. Most see then an increase in the tertiary. They do not understand the very nature of the process. Indeed, the so called secondary sector impacted not only on farming, but on all economic activities. b) The specific way for the manufacturing sector to expand is not by division and specialisation of labour – which was already achieved to a high degree in the very ancient societies –, but by the shortening – remember the word, shortening, I will return to it later in this paper when dealing with position ii) – of the Karl Marx cycle, which I rewrite as labour-goods-labour-goods, omitting money, to make obvious that the underlying cycle in activities implies that both goods and labour have to go to the market place, and be there transformed for a while into money. Hence, the simultaneous development of the secondary sector and of the market economy not only distracted labour from all other activities, but also forced them to increasingly be evaluated through the official market pricing system, a second source of confusion for economists.

In truth, concepts are essential in the understanding of any science. Confusion can only result when science sleeps with politics, and this is too frequently the case with economics. Why ? Simply because economics, rather than being the pure science of efficiency in the applied human work, pretends to be also concerned with groups of individuals with conflicting interests. Here, to avoid any confusion, I start from the very basic definition of economic progress as an improvement in the efficiency of the human individual work targeting the satisfaction of his needs. No group behavioural or political theory is required to understand that the stick used by the Kohler monkey improved its efficiency in collecting food. What scientifically matters is not whether the idea of using a stick was purely fortuitous, resulted from intelligence, imitation of others or a trial-error process. What matters, here, is the efficiency of the stick. This can be measured in a purely scientific way: length, form, weight, etc… in relation to the objective.

How do we achieve this improvement in the efficiency of the human individual work ? This is achieved through the medium of tools and, further, by the replacement of human action by machines, a whole concept that is understood under the commonly used expression machinery and equipment – which I will designate in this paper under the generic term machines. And this concept is a valid one when considering any kind of action, be it physical or intellectual. Machines can replace people on the farm, as well as in workshops, offices, and even in the house – would you say that the house wife worked in the tertiary sector when she was staying at home, cleaning, preparing the food and educating the children ? If not, then don’t tell us that she is working in the service industry when she serves food in a restaurant and uses the money she earns to buy dish washers and all that sort of things to help her in her home work.

ii. Now, what makes the efficiency of the machine ? This is, fundamentally, the number of human actions it can replace per unit of time. Hence, the faster a machine acts (some would say run), the more it provides to the human, and the greater the improvement in the power of his work. This is something quite different from what most call labour productivity which is the concept of the employer, only seeing the size of the output per unit of time of an employee work, and not considering whether this size results from machine intervention or work intensity. My principal statement in this paper is that there is for a definite period of time an absolute limitation in the speed (i.e. number of actions per unit of time) of the machine. This limit is fixed by the degree of accuracy achieved in time measurement, i.e. the signal frequency of the commonly used clock.

There are stages in economic development. Each of these stages coincides with a state of the art achieved in the measurement of time. By state of the art, I mean the clocking system that is widely used and recognised as a common referential by humans, not only to display time as a chronology – this is today achieved with a watch for example –, but also to drive the automated sequence of a machine, i.e. the repetition of units of action by the machine.
By stages in economic development, I mean a) that the level reached in knowledge and arts lead to qualitative changes at certain intervals in history in the way this measurement of time is commonly operated, and, b) that, after a qualitative change has been operated, the new level of achievement is maintained during a certain period of time – as it requires an adaptation of the entire system of work and communication in society. The idea of a continuous gain in the accuracy of time measurement is purely theoretical. However, it permits to embrace the total potential of improvement in human work efficiency resulting from the use of machines. This is what mathematicians would call a continuous function corresponding to an extreme reduction of the repetitive intervals of time, such as the exponential function being the limit in compound interests. This also defines the theoretical ultimate target of investment (as a means to improve work efficiency), i.e.: an extreme shortening of the above mentioned Karl Marx cycle labour-goods-labour-goods. And the theoretical approach is always appropriate in evaluating business potentials. But the reality is that of human groups and societies with their rigidities, and a portion of irrational faith required to make humans accept the building of machines that may well last longer than their own lives. Therefore, in the real world, improvements in the accuracy of time measurement are not achieved in a continuous manner, but rather, step by step. And this is what makes history, including the history of economic development.

To be less abstract, I will shortly describe the economic stages that have been experienced in relation to the accuracy achieved in time measurement: a) measurement of time with outdoors signals, such as those given by the position of the sun during the day and of stars or planets during night time, b) measurement of time with indoors signals relying on mechanisms such as the hourglass, the water clock, further then, the mechanical clock, and, more recently the quartz crystal driven clock. In this short paper I cannot extend at length on the relationship between these various measurements and the corresponding states of the art achieved in automated machines utilised to replace human work. It is however easy to see the long walking, from the first Egyptian irrigation systems relying at their very beginning on outdoors reference marks for time measurement, with only a few signals per annum, to the efficiency of today’s computer driven automates relying on millions of quartz signals per second – hence enabling millions of repetitive operations per second.

Economists have not taken into account the notion of relativity in time in their thinking. But physicists know from Einstein theory, that time and space are part of the same set of dimensions, i.e. when moving in space, you also move in time. As some physicists put it: the Past and the Future, as much as the Present, are somewhere out there in space. We already foresee the gigantic step forward that molecular chemistry will accomplish in the near future following the huge progress made in the accuracy of time measurement. We will possibly see this revolution in economic thinking in the coming decades. We will understand that the acceleration of economic action has tremendously increased the number of economic events per unit of time and space. Economic forecasting methodologies will hopefully understand the fundamental link between historical and repetitive time, and finally reach the status of a science, i.e. the true ability to predict, because it will be able to distinguish between the time of uncertainty, i.e. the time of history and politics, and the time of certainty, that is time as a an indefinitely repeated sequence, as foreseeable and safe as the beat of the grandpa clock.

15th December 1999.
Copyright © 2000

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Contesting the Central Piketty Argument

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Matt Rognlie April 10, 2014 at 2:45 am, wrote :

« Krugman correctly highlights the importance of the elasticity of substitution between capital and labor, but like everyone else (including, apparently, Piketty himself) he misses a subtle but absolutely crucial point.

When economists discuss this elasticity, they generally do so in the context of a gross production function (*not* net of depreciation). In this setting, the elasticity of substitution gives the relationship between the capital-output ratio K/Y and the user cost of capital, which is r+delta, the sum of the relevant real rate of return and the depreciation rate. For instance, if this elasticity is 1.5 and r+delta decreases by a factor of 2, then (moving along the demand curve) K/Y will increase by a factor of 2^(1.5) = 2.8.

Piketty, on the other hand, uses only net concepts, as they are relevant for understanding net income. When he talks about the critical importance of an elasticity of substitution greater than one, he means an elasticity of substitution in the *net* production function. This is a very different concept. In particular, this elasticity gives us the relationship between the capital-output ratio K/Y and the real rate of return r, rather than the full user cost r+delta. This elasticity is lower, by a fraction of r/(r+delta), than the relevant elasticity in the gross production function.

This is no mere quibble. For the US capital stock, the average depreciation rate is a little above delta=5%. Suppose that we take Piketty’s starting point of r=5%. Then r/(r+delta) = 1/2, and the net production function elasticities that matter to Piketty’s argument are only 1/2 of the corresponding elasticities for the gross production function!

Piketty notes in his book that Cobb-Douglas, with an elasticity of one, is the usual benchmark – and then he tries to argue that the actual elasticity is somewhat higher than this benchmark. But the benchmark elasticity of one, as generally understood, is a benchmark for the elasticity in the gross production function – translating into Piketty’s units instead, that’s only 0.5, making Piketty’s proposed >1 elasticity a much more dramatic departure from the benchmark. (Keep in mind that a Cobb-Douglas *net* production function would be a very strange choice of functional form – implying, for instance, that no matter how much capital is used, its gross marginal product is always higher than the depreciation rate. I’ve never seen anyone use it, for good reason.)

Indeed, with this point in mind, the sources cited in support of high elasticities do not necessarily support Piketty’s argument. For instance, in their closely related forthcoming QJE paper, Piketty and Zucman cite Karabarbounis and Neiman (2014) as an example of a paper with an elasticity above 1. But K&N estimate an elasticity in standard units, and their baseline estimate is 1.25! In Piketty’s units, this is just 0.625. »

Source : http://marginalrevolution.com/