Sunday, April 16, 2017

Human Capital (Potential) as a Solow Residual Issue

Do firms need to rethink their organizational patterns? Last month, the Stigler Center at the University of Chicago (with Harvard Business School and Oxford University) hosted a conference in Chicago, and these were the primary questions they sought to answer:
Should the economic theory of the firm be modified? And if so, how?
Since then, the ProMarket blog has highlighted numerous elements from the ensuing discussion, and the most recent post was titled "The Sense that the System is Rigged Relates Directly to Government's Failure to Address Inequality and Concentration". Concerns about declining labour share of income are also driving discussions such as these. But how does one blame inequality and business concentration on government - insofar as a failure to address the problem?

While governments can certainly be held responsible for the extensive requirements of economic entry; the limits of employment potential in the subsequent institutions which operate in these environments are a rational institutional response, given the budgetary demands involved. In other words, if costs are not "concentrated" in the areas they are absolutely essential, bills may not get paid. Time value as an intangible contribution is also an important concentration element. Employment in such enterprise is not just limited by Solow Residual factors, but administrative requirements which separate classes of work and income out of budgetary necessity.

Again let's take a brief look at the Solow Residual description, from Wikipedia:
The Solow Residual is a number describing empirical productivity growth in an economy from year to year and decade to decade. Robert Solow defined rising productivity as rising output with constant capital and labor input.
Of course, the Solow Residual contributes to greater productivity in specific institutions through a gradual reduction of labour force participation. Whereas assumptions of constant labour input (alongside capital) exist at aggregate levels.

In earlier posts I've noted how aggregate output has been increasingly maintained with less labour. More concerning, nonetheless, is the possibility these circumstance may gradually lead to less output as well, over time. In particular: as services assumed economic dominance, their secondary formation (dependence on other revenue) could also compel these sectors to reduce ongoing participation with technology, wherever it is possible to do so.

Does any of this suggest the economic theory of the firm should be modified? I would argue instead, that the definition of the firm needs to be expanded, so as to address the growing problem of a lack of human capital representation. That said, the full management of human capital potential runs counter to the mechanism by which progress thus far has evolved. Hence an evolved example of a new firm, needs to clearly designate itself as a separate entity in multiple respects, from what currently exists. Particularly since today's institutions appear to utilize "additional" capital which in reality tends to be either "hidden" human capital, or human capital in replicated form.

Still, this latest arrangement is neither right or wrong. It is simply the latest designation of organizational patterns which - for the most part - have contributed to progress through the careful management of resource capacity.

Whereas in the equilibrium corporation, the resource capacity that is the focus of management, is the actual environment of human capital potential. In this setting, human capital is not just a matter of aggregate input, but also the most active resource component of aggregate output. The equilibrium corporate designation, would distinguish both product output and labour force participation, somewhat differently from the normal functions represented by the Solow Residual.

Hence the object is not to change what continues to work, but to build an institutional function which relies on a different mechanism for long term progress than the Solow Residual is now able to provide. For instance: when input and output are recognized as part of the same mechanism, it becomes possible to envision the benefit of reduced costs for mutual self employment, because they apply to all parties involved.

We cannot know the monetary consequence of this relationship presently, because it must first exist in a context of direct association with tradable production capacity and asset formation. What we do have, is an understanding of human capital as the capital component of input, as represented in time units. Nevertheless, quality gains in time based product could be measured as a ongoing story line, that might hold equal importance with the monetary factors involved.

The Solow Residual proved an apt explanation of progress for the Industrial Revolution and well beyond, as previous forms of labour input could be applied elsewhere as economies continued to diversify and grow. Yet as production capacity was gradually reduced at local levels, the potential of better management for local human capital, went unrecognized for too long. It's time to provide that recognition, and build a new relationship for aggregate input and output in terms of time based product.

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