Friday, January 8, 2016

Notes on Solow Model Effects in General Equilibrium

I had begun a post yesterday on this subject only to delete it, links and all. Yet today these thoughts remain uppermost in my mind, so I'll try again from a different angle. The Solow model in general equilibrium, is an instance when microeconomic effects also play a substantial role in macroeconomic outcomes. The (internal) labor force substitutions implied by the Solow model, have played out in slow motion in recent decades, as tradable goods formation has given way to the growing wealth of non tradable sectors.

As best as I can tell, interest rates began their long term decline, once the consumption requirements of housing/services and their accompanying credit became more important for non tradable sectors. These revenues provided additional funding for asymmetric compensation, in what could be termed a steady state economy around 1980. Many governments increased their reliance on asset formation during these years, as tradable goods wealth became less prominent. According to Wikipedia,
The steady state economy is an entirely physical concept. Any non physical components of an economy (e.g. knowledge) can grow indefinitely.
Of course - unfortunately - it has quite become obvious that knowledge use has not been able to grow indefinitely, once nations reach a certain degree of maturity in their tradable goods structure. Citizens are increasingly on edge, as the still secondary role of knowledge use, places time based services into the crosshairs of competing groups.

Today's services formation claimed their dominant role in the wealth of GDP, through following the Solow model as it had been utilized by tradable sectors. Again, these organizational patterns kept capital and labor in check, while focusing on output growth. But what about the results? While this time based product approach should contribute to per capita growth, it's the fixed capital and labor (in relation to output), which places internal limits on both time value and knowledge use (human capital) options. These limits - in turn - affect both the nature of time based product, and ultimately the dispersal of knowledge which is associated with time value.

Hence the Solow model for time based services organization, may negatively affect both aggregate participation and aggregate knowledge use gains. Diversity in knowledge use options is at stake, when time value is replaced by separately existing (duplicative) product to protect the bottom line and limit expense in asymmetric compensation.

Instead of knowledge use growth, asymmetrically compensated services increased output by generating product which substituted for time value. One example is the use of prescription drugs, which now substitutes for a wide range of time based healing activities that were employed for centuries. In other words, less time has been asymmetrically compensated for the specific circumstance involved between provider and recipient, to arrive at the desired services product. Likewise for what had been more spontaneous forms of research, prior to the twentieth century.

Why is this problematic, in terms of aggregate output and labor force participation? First, recall that services organization is not yet offered as free standing wealth, and its formation remains nested within the wealth creation of traditional production. Institutions reduce labor costs, in part because asymmetric compensation relies on preexisting revenues. Even though asymmetric compensation is logical - given wide variations in aptitude - this approach remains dependent on a growing tradable sector, in order to maintain employment capacity. Presently, worldwide tradable sectors have become somewhat weakened, by the fact that time value is not a source of wealth creation in its own right.

Consider why the Solow Model was able to maintain strong labor force participation, for so long. The Solow model was perfectly suited for tradable goods formation, given the fact that tradable product value need not be affected with a smaller time component. Also, the Solow model of reduced labor force participation (in time based services) relative to output, was not problematic decades earlier, so long as tradable sectors were growing in relation to non tradable sectors. The present problem occurred, as non tradable sector growth gradually overtook tradable sector growth. Instead of directly addressing the issue as it developed - however - governments in developed nations used asset formation, to compensate for their loss of revenue flows from tradable sectors.

Once the greatest benefits of the Solow model process became sidelined, government compensated by raising the consumption requirements for both asset formation and services product in non tradable sectors. Prior to the eighties, when individuals lost a job, they were often able to gain new work through still growing diversity in tradable goods formation. Finally, tradable goods sectors lost the ability to generate more labor force participation at aggregate levels. From that point forward, services employment developed insofar as these sectors received revenues from asset formation and the remaining redistribution of traditional manufacture.

Clearly, the Solow model - "workhorse" though it remains for tradable goods structure, is insufficient for the potential growth and stabilization of time based services - either in mature economies or developing economies for that matter. When the most important product is time based, one cannot remove time value from the equation and expect the same result in terms of knowledge use diversity and human capital.

Without a clearly designated marketplace which represents the finite nature of time value, productivity is lost because individuals can't discern time value in relation to one another (i.e. comparative advantage). Without this capacity, civility in general also suffers. Hopefully, production gains for the 21st century can be approached through better organizational capacity, than what has transpired thus far.

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