The Dynamics of Capitalism: Unemployment and Wage Inequality

A constant theme in Rowthorn’s work has been his focus, both theoretical and applied, on the major aspects of the dynamics of capitalism. He returned to this again in his 1995 paper in the Oxford Review of Economic Policy. Here, Rowthorn tackled two issues. First, the sharp rise in unemployment which had taken place in the OECD economies since the 1970s. Second, the increase in wage inequality, which had reversed a long-run trend towards greater equality. Rowthorn returns to the framework of his 1977 macro model discussed above. He argues that both these phenomena can be explained by a shortage of capital stock.

The prevailing orthodoxy at the time was that unemployment was primarily generated by imperfections in the labour market. For example, the quality and skill of the workforce and the level of benefits relative to wages. The work of Richard Layard and Steve Nickell was particularly influential (Layard and Nickell 1986). Rowthorn takes the Layard- Nickell theoretical model and shows that their result that the equilibrium rate of unemployment is independent of the capital stock depends upon the assumption that the production function is Cobb-Douglas, specifically, that the elasticity of substitution between capital and labour is one. Rowthorn points out that, as he did nearly two decades later with Piketty, the empirical evidence is that it is less than one. With this assumption, he shows that in the Layard-Nickell model itself, unemployment depends upon the capital stock.

In Rowthorn’s own model, the capital stock is a determinant of both unemployment and wage inequality. An inadequate level of capital stock, whether brought about by premature scrapping or investment being too low, leads to unemployment in economies where the level of flexibility in the labour market is low. Unemployed workers find it difficult to reduce their wages so as to price themselves back into work. Further, the level of benefits in such economies will typically be reasonably high relative to the wage, reducing their incentive to return to work. With flexible labour markets, of course, workers are more willing to reduce wages, and the effect is to create a situation with lower unemployment and higher wage inequality. Again, Rowthorn looks for empirical evidence with which to confront his theory. He finds positive evidence across the OECD in the case of manufacturing but not the services sector.

The 1995 paper is a useful focus for a number of additional themes. In terms of economics, Rowthorn himself rationalises the lack of evidence on the influence of the capital stock on unemployment in the services sector as follows: ‘[It is] a sector where information technology is so important. [The result] may also be due to the fact that substitution between labour and capital is on average easier in services than manufacturing, and that many services use very little capital at all’ (Rowthorn 1995: 34). The insights on the importance of IT and the low level of capital per worker in the services sector are even more important today, two decades after the publication of the article. The services sector is not only by far the dominant sector in the Western economies but a rapidly rising share of services is delivered through the technology of the Internet. Concepts such as the output gap remain of great significance in policy circles. But these developments render it virtually useless. The marginal cost of delivering many services via the web is close to zero, and in such situations output can be expanded virtually without limit. More generally within services, measured output is itself positively related to the level of demand. The price which a restaurant or a consultant, say, can charge at different points in time for an identical service depends upon the state of demand. The higher the demand the higher the price of output, for the same level of inputs and physical embodiment of the output.

The paper also, rather tantalisingly, develops briefly three other themes. The first of these is the importance of the long-term real rate of interest. This was stressed by Keynes but has been almost entirely ignored by many so-called Keynesians in the ongoing debates over austerity. Rowthorn also regards high real rates of interest as a deterrent to capital accumulation and hence creating higher unemployment. He notes that, by the mid-1990s, many OECD economies had run structural fiscal deficits for some considerable time. These, combined with both a relatively low level of personal savings and rising demand for investment funds in developing countries, lead, in this classical model, to high real interest rates. The situation is rather different at present, but the experience of the Mediterranean economies shows how easy it is to generate high rates on government bonds if the markets lose confidence in the fiscal probity of a government. Rowthorn made the point at least as early as his 1995 paper that structural government deficits were not necessarily a good thing. High long-term interest rates will either deter borrowing to invest by depressing animal spirits or encourage companies holding cash to lend it to the government, or return it to shareholders. Either approach reduces the use of available funds for investment. Further, there is a reduction in net wealth of the private sector following the revaluation of the stock of government debt which it holds. All this shows how government debt can reduce economic activity.

The second point, which is a consistent theme of Rowthorn’s work, is the importance of institutions. Economies do not operate in abstract settings in which the Walrasian equations are ground out. The particular institutional structure is often of decisive importance to the outcome, or potential range of outcomes. Mainstream economics, to be fair, implicitly assumes a set of institutions such as the rule of law and the enforceability of contracts. But Rowthorn goes much further than this. So in his 1995 paper, for example, the impact of a shortage of capital stock will be seen as a mix of higher unemployment and increased wage inequality, the relative weights of the two depending upon the extent to which any given economy is what Rowthorn describes as ‘regulated’ (ibid.: 31).

The third theme is the role of profit share in the determination of capital investment. This serves as a potential link to the growth cycle model of Richard Goodwin, also a Cambridge economist, based upon a Lotka-Volterra system of non-linear differential equations, in which the dynamics cast the workers in the role not of prey but of predator on the profit share of the capitalists. Meghnad Desai and I wrote a short appreciation of Goodwin’s work in 1998 in the Economic Journal, shortly after his death, stressing in particular the power and originality of this model. In terms of what might have been perhaps a Rowthorn-Goodwin collaboration could have synthesised a macro model which would have been scientifically far superior to the real business cycle, and subsequently dynamic stochastic general equilibrium (DSGE) models which came to dominate economics.

Of course, this hypothesised collaboration is mere speculation, but the fact is that Rowthorn did write purely by himself for much of the time. He is the sole author of a clear majority of his published articles. It is certainly not the case that he was secretive or found it difficult to relate to others. Far from it. As already noted, he is a very generous person, willing to share ideas, assist others in developing theirs, and always trying to see good points, even in arguments which he thought were incorrect. For these reasons, generations of King’s undergraduates have regarded him as an outstanding teacher. One problem for Rowthorn has been that his ideas, his ways of analysing issues, are often strikingly original, at odds with the conventional thinking of the time. So the supply of people, as it were, with whom he could collaborate was limited.

Andrew Glyn was by far his closest collaborator. It is Glyn who stressed the role of profit share in the dynamics of capitalism, and it is to Glyn that Rowthorn refers several times in the 1995 paper. Glyn’s premature death in 2007 was a great loss to Rowthorn. Glyn was also an original thinker, though perhaps rather more discursive in his work with not quite the same degree of mathematical rigour with which Rowthorn has always been capable of bringing to bear on a problem. But they saw eye to eye on many issues, not least on the great theme of Rowthorn’s work, namely the dynamics of capitalism.