The Real Economy

From nominal growth to stable real incomes

Hector McNeill¹
SEEL

The trends over the last 5 years see a repeat of the initiation of a 1975-type slumpflation. The "solution" at that time was inappropriate. It led directly to a slow cascade of events that culminated in the 2008 financial crisis. The nature of macroeconomic policy and regulatory frameworks accelerated rises in temperature. We are now faced with trying to sort these issues out.

Some of the members of the Committee reviewing the world's performance of the UN Sustainable Development Goals said there was a direct correlation between "economic growth" and rising income disparity, falling sustainability and accelerated climate change. Where there was growth, these indicators went into reverse. Following "editing" the resulting 2019 UN Sustainability Development Report made no mention of this direct correlation. However, continuing with the same macroeconomic policy framework cannot solve the climate crisis.

COP 26 has not produced any credible proposals for action. Achieving "Net-zero" will not reverse temperature rises but "Net-negative" could achieve this. This fact is missing from the deliberations.

The financial services sector with Ł trillions to invest has a very poor project performance record making "plans for action" unlikely to achieve timely practical results.

Why it wont work

The central bank central government top down macroeconomic aggregate demand approach has resulted in a mess. But the policy makers wish to continue with the same paradigm to solve even bigger issues associated with the climate crisis which has been caused by the current macroeconomic model. Von Mises explained the issue in 1920 as a "calculation and knowledge" problem" of trying to herd a flock of millions of different sector entities along some policy pathway usually aiming to "control demand" (see: Ludwig von Mises' calculation and knowledge problem revisited).

The Say model of the economy which was destroyed not for any rational or logical reasons but rather because after the Great Depression, Keynesianism was regarded as the major leap forward in economic thinking at the expense of all other paradigms. In 1967, the UK had completed a period of rapid growth, rising real incomes and a decline in income disparity. Although this period was considered to be the golden age of Keynesianism, the evaluation by Robin Matthews at Cambridge University, demonstrated that no Keynesian policies had in fact been applied since there had been a national account positive balance and relatively stable balance of payments. In fact policy has been strongly deflationary and yet the economy grew strongly.

In reality, this was a demonstration of the Say model in action. The Say model explains that consumption (demand) arises as a function of the rates of pay of wage-earners and therefore depends intricately upon investments that enhance productivity opening space for lower unit costs, higher profits, flexibility of the fixing of competitive pricing as well as raising wages. This was the outcome of the period 1945-1965 in Britain. A variant on this "growth model" is what is needed under current circumstances and can be summarized as "more for less". This has two connotations:

We use less natural resources to support needs
Our needs or real incomes need to adjust to the ability of the ecosystem to satisfy these on a sustainable basis

On the ecological sustainability and climatic fronts such models were discussed in seminars at Cambridge and Stanford Universities in 1967 and 1968 both entitled "Population & food supplies" and were contained in the MIT work published in 1972 as "The Limits of Growth" by the Club of Rome. At the time it was more feasible for policies to be adjusted to steer our economies in the ecologically sustainable direction. However, this period was followed by three critical events in short succession:

We came off the gold standard in 1971 because of failures in US financial administration (See: Bretton Woods in retrospect)
Wars in the Middle East led to massive rises in petroleum prices leading to worldwide slumpflation crisis (high inflation combined with rising unemployment)
Keynesianism was replaced by monetarism as the central macroeconomic policy paradigm

Two new paradigms: Supply Side Economics and the Real Incomes Approach

Two new approaches emerged in reponse to slumpflation in the mid-1970s. These were "supply side economics" and "the real incomes approach to economics". "Supply side economics" does not have much to do wit the supply side and is a fiscal marginal taxation variant. Like Keynesianism and monetarism the applied logic is the same Aggregate Demand Model (ADM). In practice it morphed into Reaganomics and did not work effectively.

"The Real Incomes Approach to Economics" is completely supply side and the only new macroeconomic paradigm to address the calculation and knowledge problem. It avoids the default policy position of the ADM model and can be considered to be a Say model. The logic of the Say model is clear from the title of Say's main treatise title as well as the model developed by the Real Incomes Approach

The Say model (Jean Baptiste Say, 1767–1832) does not refer to demand in his "A Treatise on Political Economy" making a clear distinction between a nebulous concept of "demand" and the more explicit "consumption". The sub-heading of his book was, "The Production, Distribution and Consumption of Wealth." His model created a dynamic balance between wages and disposable income and the levels of feasible consumption of the output of agriculture, industry and services. This consumption fed the supplying sector with their revenues. A century later, it would seem, Henry Ford (1863–1947) was asked why he paid his workers such high wages. His logic was that in this way they would be able to afford to buy the cars his company manufactured. Ford understood and responded in practice to the logic of the Say model.

Real Incomes Approach Logic

The Real Incomes Approach applies the logic of the Say modem in a "Production, Accessibility and Consumption Model". Notice the term "accessibility" that refers to accessibility of prices in relation to disposable incomes as well as local availability and support to products and services.

In terms of a macroeconomic policy the policy instruments provide a direct incentive for economic entitles to stimulate consumption through competitive prices rather than through pumping volumes of fiat currency into the economy raising debt.

This price performance policy is the only macroeconomic policy proposition that recognises the "calculation and knowledge problem" and distributes the determination of the main policy instrument values to economic entity and workforce levels enabling refined optimization of production throughout the economy.

Replacing "planning" with a proactive competitive economy

Plans are an attempt to map out desired future pathways and transitions. However, because all economic entities are different in all critical and general factors of performance the attempt to achieve "centralized plans" encounters a wide range of impediments and constraints because central planning cannot manage the "calculation and knowledge problem" which can only be addressed by each entity in response to their particular circumstances. This means central plans impose varying levels of risk on companies.

To solve the risk, calculation and knowledge issues the Real Incomes Approach devolves the manipulation of policy instruments to the level of economic entities in a way that is advantageous to companies in any state of circumstances. This is achieved by encouraging competitive price setting against productivity enhancing investment through an incentive scheme. This augments immediate profits to the degree that unit prices kill inflation while penetrating the market and enhancing the general state of real incomes. The general state of real incomes signified real income of companies and purchasing power of consumers. In other words rather than a fixed plan the economy is managed through a set of targets for the future performance of corporate PPR-price performance ratios. The PPR provides an indication of the degree to which the supply chain individual firm activities impact real incomes as a result of the summation of unit input costs (transacted) and the unit output prices (transacted). This occurs across a transformation process including: input procurement (transaction), external input logistics, internal input logistics, transformation process, internal output logistics (product or services), product sales (transaction), external output logistics (product or services) and delivered product or service.

Innovation target zones

With current technology, techniques and accumulated tacit knowledge, there is a frontier beyond which we cannot operate with state of the art technology (See: Tacit & explicit knowledge). For example if unit input costs rise by 20% it would normally be difficult to secure an immediate 20% reduction in unit output prices without losing a considerable amount of money. However, through re-adaptations of state of the art, systems engineering and rational decision analysis it is usually possible to redesign processes and maximize process throughput so as to accelerate the evolution of technological and economic performance. In this way it is possible to enter the innovation target zones. This leads to a significant rise in supply side-generated real income as a result of lower unit prices and market penetration. The innovation target zones, desirable and undesirable states are shown in the table below.

Price Performance Ratios (PPRs)
associated with different unit input value movements & movements in unit output prices

Unit input costs	Unit output price change %
change %	-20	-15	-10	-5	0	5	10	15	20
20	This area represents the innovation target zone				0.00	0.25	0.50	0.75	1.00
15					0.00	0.33	0.66	1.00
10					0.00	0.50	1.00
5					0.00	1.00
0	0.00	0.00	0.00	0.00	0.00
-5	0.25	0.33	0.50	1.00
-10	0.50	0.66	1.00
-15	0.75	1.00
-20	1.00

Innovation target zone

Desirable states

Undesirable states

This table provides a map of the distribution of likelihoods of sources of enhanced real incomes. However, the extent of real income generation at the macroeconomic level can only be estimated by applying sector demand schedules for local and regional markets. In the case of global markets, the elasticity of demand for price-setters is well above the market norm so the returns to lower PPR states are enhanced by market penetration, returns to scale, better procurement conditions and the accumulation of tacit knowledge leading to quantifiable increases in performance measured in terms of unit costs of production.

The PPR map is not only a useful guide to feasible attainment in terms of real income growth according to the sector/technologies but it also provides a map of targets for research and development and technology requirements. At all times these explicit descriptions will be improved, in practice, through the refinement of techniques, that is, the way people apply technology, achieved through practice and the further accumulation of tacit knowledge. The PPR map also provides an indication of the evolutionary transition of where we stand today in terms of the given past and the necessary future.

Why the Real Incomes Approach is different>

The Real Incomes approach makes use of such factors as critical policy and business rule resources. It makes use of them by influencing transactional behaviour to stimulate the proactive application of these growth factors. It is notable that the main conventional texts on Keynesianism, monetarism and supply side pay scant attention to these factors and as a result provide no basis for gaining traction and real economic growth when attempts are made to apply these theories as policy.

The incentive to encourage increased competition associated with lowered risk

The incentive for decisions that support the general national objective is a PPL-price performance levy. The levy is a withholding levy where rebates, or levy reductions, are proportional to the price performance ratios achieved. These should be set to enable efficient companies (those with low price performance ratios) ending up paying no levy at all.

The logic of this free flowing system is that there will always be a future desirable PPRs and the way to achieve them in a reduced risk manner is to improve technologies and techniques to secure more for less and thereby reduce the pressure on resources.

Population and behaviour

Our main issue remains excessive population growth combined with behaviour and habits that extract too many resources and with the excuse this is to feed the future generations of an expanded population. This is illogical and family planning techniques need to be made more widely available to enable people to change behaviour. The most striking example of population control being a success story in terms of pulling more people out of poverty was that of China that adopted the one child policy in the 1980s after an assessment of the limits of growth".

Finance

The Say model and the Real Incomes Approach does not rely on loans and debt to secure "growth". As soon as an economic entity develops a competitive level of operations, the monetary savings resulting are often sufficient to begin to invest marginal improvements so, improvement feed on improvements. The other options is mutual arrangements where a group work as employed in their own company and share saved margins to improve their performance. Price performance policy assists this trend by ensuring efforts at increased performance either through investment and or price setting can result in immediate levy reductions thereby reducing risks.

The financing option of loans and debt is at all time risky with around 30% of all projects failing and companies losing their assets to financial entities. This level of transfer of ownership of assets is recorded as part of he success of the financial sector while in reality it represents a loss to the productive sector. Amongst the "solutions" advocated by the financial interests is increased Carbon trading which to date had not achieved any improvements in temperature rises. COP26 was informed that the carbon price it too low. No one really knows because of the calculation and knowledge problem linked to intentionally exaggerated carbon capture estimates combined with intentionally underestimated emissions estimates. This system is far from transparent but remains a convenient way to earn commissions. The financial sector is the closest to central banks and they are also the main sources of funds for political parties and the media. They wish to continue business as usual but relabeling their modus operandi as a green initiative. The aggregate demand model needs to be replaced with the production, accessibility and consumption model and this signifies a need to introduce price performance policy.

¹ Hector McNeill is director of SEEL-Systems Engineering Economics Lab

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