Hahnel ABCs of Political Economy Modern Primer

46 The ABCs of Political Economy

person needs to consume exactly 1 unit of corn per week. After their “necessary consumption” we assume people care about leisure. That is, after consuming 1 unit of corn, people care about working as few days as possible in order to enjoy as many days of the week in leisure activities as possible. Finally, we assume that after consuming 1 unit of corn and minimizing the number of days they have to work, i.e., maximizing their leisure, if people have the chance to accumulate more corn rather than less they will want to do so.1 There are two ways to make corn: a labor intensive technique (LIT) and a capital intensive technique (CIT):

Labor Intensive Technique:

6 days of labor + 0 units of seed corn yields 1 unit of corn

Capital Intensive Technique:

1 day of labor + 1 unit of seed corn yields 2 units of corn

In either case the corn produced appears only at the end of the week. That is, if I work Monday through Saturday using the labor intensive technology I will get a yield of 1 unit of corn on Sunday. If I work with a unit of seed corn on Tuesday using the capital intensive technology the unit of seed corn is tied up for the whole week and is gone by Sunday, and I will get a yield of 2 units of corn on Sunday. There is no need to replace seed corn used in the labor intensive process since none is used. On the other hand, if we are to get back to where we started after using the capital intensive process, we need to use 1 of the 2 units of corn produced to replace the unit of seed corn used up. Another way of saying this is that the capital intensive process produces 2 gross units of corn but only 1 net unit of corn. So each technique produces 1 net unit of corn available at the end of the week. The labor intensive process uses 6 days of labor and requires no seed corn to get 1 unit of corn, net. The capital intensive process uses 1 unit of labor and requires 1 unit of seed corn to get 1 unit of corn, net. Finally, we assume either technique can be used in

1.Obviously this simple model deviates from real world conditions in many respects. The assumption that people only wish to consume 1 unit of corn, after which they wish to minimize work time, after which they wish to maximize accumulation is convenient for now. We will consider the implications of people’s preferences for how they work, and who decides how they work, and discuss the effects of more realistic assumptions about consumption and savings later.

A Simple Corn Model 47

any “scale” desired. For example, if I work only 1 day in the LIT I will get 1⁄6 unit of corn on Sunday. If I work half a day in the CIT I will get 1 unit of corn gross, and half a unit of corn net on Sunday.2 But why would anyone ever produce corn the labor intensive way? If I work 1 day using the capital intensive technique I can produce 2 units of corn, and after replacing the 1 unit of seed corn I used up I have 1 unit left over. On the other hand, I would have to work 6 days to end up with 1 unit of corn if I used the labor intensive technique. So no one would ever use the labor intensive technique if she could use the capital intensive technique instead.3 However, a key feature of the model is that you cannot use the capital intensive technology unless you have seed corn to begin with. So if someone does not have access to seed corn, yet needs to produce more corn, they have no choice but to use the labor intensive technology. This is how the model nicely captures one critical feature of modern economies – the role of capital, represented in our model

by seed corn.

In our simple corn economy there is an easy way to measure economic efficiency. What people want is net corn production. In other words the only benefit people get from the economy is net corn production. On the other hand, what people don’t like is working since it detracts from their leisure. In other words the only burden people bear in the economy is the amount of time they have to work. In this simple situation the economy is more efficient the lower the average number of days of work per unit of net corn produced.4 So we can measure the efficiency of the economy by the average number of days worked per unit of net corn produced. There is also a simple way to measure the degree of inequality in the economy. Since everyone consumes the same amount of corn, 1 unit, the only difference in outcomes that people care about is the number of days they have to work. So we can define the degree of inequality in the economy as the

2.In other words, we are assuming what economists call “constant returns to scale.”

3.Remember we are assuming for now that people don’t care whether they work an hour in the labor intensive process or the capital intensive process.

4.Efficiency means minimizing the ratio of “pain” to “gain.” “Pain” in our simple economy has been reduced to total number of days worked, and “gain” has been reduced to the total number of units of net corn produced. So average days worked per unit of net corn, or total days worked divided by total net corn production, is the obvious measure of efficiency in our simple corn economy.

48 The ABCs of Political Economy

difference between the maximum number of days anyone works and the minimum number of days anyone works.5

To explore how the distribution of seed corn and economic institutions like a labor market and credit market affect efficiency and inequality in the economy we explore two different situations and three different sets of rules for how people can behave in the economy. In situation 1 we give some people more of the economy’s scarce seed corn than others. This situation is obviously most relevant to real world circumstances where some people have more capital than others. In situation 2 we give everyone equal amounts of scarce seed corn. While there has never been a capitalist economy in which everyone started out with the same amount of capital, nonetheless, it is interesting to explore what would happen in this situation as compared to the real world of unequal endowments of scarce capital.6 In each situation we explore what people would do under three different sets of rules. First we do not permit people to enter into any kind of economic relationship with each other at all. That is, we require people to be completely self-sufficient. This rule, or way of running the economy, we call autarky. Next we permit people to enter into an employment relationship where anyone who wishes to hire someone, and anyone who wishes to work for someone else, for a wage the employer and employee both agree to, are free to do so. In other words, we legalize, or open a labor market. Finally, instead of opening a labor market, we open a credit market. Under this third set of rules people are free to borrow corn from others and lend corn to others at a rate of interest both borrower and lender agree to.

Political economists define classes as groups of people who play the same economic role as one another, but enter into economic relationships

5.Shortly we will discover that our measure of the degree of inequality is imperfect whenever people accumulate different amounts of corn. Our measure also fails to address changes in the degree of inequality between people who are not at the upper and lower extremes. But this imperfect measure is sufficient for our purposes, so we avoid unnecessary complications involved in devising a better measure.

6.What does it mean to say capital is “scarce” in our simple economy? As long as the total amount of seed corn in the economy is insufficient to allow us to produce all of the corn people need to consume using the more efficient, capital intensive technology, and thereby avoid having to use the less efficient labor intensive technology at all, seed corn is “scarce.” So as long as we have fewer than 1000 units of seed corn initially, seed corn is scarce in the sense that we could reduce the amount of days people had to work if we had more.

A Simple Corn Model 49

with other groups of people playing a different role, with whom they have conflicting interests of one sort or another. So under the rules of autarky there can be no “classes” because nobody enters into any relationship with anyone else. In autarky it may, or may not be the case that everyone suffers or benefits to the same degree from their economic activity, but any differences that occur cannot be the result of relationships people enter into with one another because under the rules of autarky everyone works for herself using her own seed corn. There are no employers (a class), nor employees (a class) with conflicting interest over how high or low the wage rate will be. Nor are there lenders (a class), nor borrowers (a class) with conflicting interests over how high or low the interest rate will be. Clearly if we open a labor market and some people become employers and others become employees classes will emerge. And if we open a credit market and some become lenders and others borrowers classes will emerge as well.

Finally, political economists distinguish between outcome – in our simple model, does one person work more or less than another7 – and decision making process – in our simple model, who decides how the work will be done. In the simple corn model if I decide what I will do and how I will do it we say my work is self-managed. If someone else decides what I will do and how I will do it, we say my labor is otherdirected or alienated. Political economists believe being human means being able to make one’s own decisions regarding how to use one’s productive capabilities. Therefore, irrespective of whether the outcome is deemed fair or unfair, many political economists believe people are being denied a “species right” to exercise their capacity of self-management when their work is other-directed or alienated. Most political economists consider self-managed decision making processes more desirable than other-directed, or alienated decision making processes.

SITUATION 1: INEGALITARIAN DISTRIBUTION OF SCARCE SEED CORN

We begin with a situation that reflects real world conditions, namely that some people begin with more of the economy’s scarce capital

7.Besides differences in work time, differences in outcome would include differences in consumption, accumulation, or desirability of working with different technologies if we allow for such differences in our model.

50 The ABCs of Political Economy

than others. We give 100 people 5 units of seed corn each, leaving the other 900 people no seed corn at all,8 and proceed to analyze what the 100 “seedy” people and 900 “seedless” people would do under three different rules for running the economy.

Autarky

Having no seed corn and needing 1 unit of corn to consume, each of the 900 seedless people have no choice but to work 6 days (Monday through Saturday) for themselves using the labor intensive technology. On the other hand, each of the 100 seedy people have plenty of seed corn and can avoid the less productive labor intensive process. Each seedy person needs only to work 1 day (Monday) using the capital intensive technology, using one of their units of seed corn. This yields 2 units of corn on Sunday. If she uses 1 to replace the unit of seed corn used up, there is 1 unit of corn left over for consumption. How efficient is this outcome? The total number of days worked is 900(6) + 100(1) or 5500 days (of work “pain.”) The total amount of net corn produced is 1000 units (of consumption “gain”). So the average days worked (pain) per unit of net corn produced (gain) is 5500/1000 or 5.500 days per unit of net corn. The maximum number of days anyone works is 6 while the minimum number of days anyone works is 1, so the degree of inequality in the economy under autarky would be 6 – 1 or 5 days.

Labor market

If we legalize a labor market the first thing to consider is if people would use it, and if so, what the wage rate would be. If I am one of the 100 seedy people I might consider becoming an employer. If I hire someone to work for me for a day with one of my units of seed corn in the capital intensive process, my employee would produce 2 units of corn on Sunday that would be mine. After using one of those units of corn to replace the one used up in the capital intensive production process, there would still be 1 unit of corn net of replacement. As long as the wage rate were less than 1 unit of corn per day I would have some corn profit without having worked myself at all.9 Provided the daily wage rate were less than a unit of corn I would be

8.This is obviously a dramatic degree of inequality in the distribution of capital. However, qualitatively none of our results depend on the degree of inequality in the initial distribution of scarce capital.

9.For simplicity we assume that supervisory time is zero for employers.

A Simple Corn Model 51

eager to become an employer. Of course if profits are positive anyone would like to be an employer, including any of the 900 seedless. But having no seed corn, if a seedless person hired an employee they would have to put them to work in the labor intensive process. Since a day’s work in the labor intensive process only produces 1⁄6 unit of net corn, the daily wage rate would have to be less than 1⁄6 unit of corn for it to be profitable for the seedless to become employers.

Who would be willing to be an employee? Since employees work (while employers do not) and receive no profits (which employers do) this appears the less attractive role to play in the labor exchange.10 Why would anyone agree to be an employee when they have the option of becoming an employer or working for themselves? If the wage rate is sufficiently high it might not be profitable for you to be an employer, and/or you might be able to get more corn for a day’s work as someone else’s employee than you could working for yourself. How high would the wage rate have to be to make it worthwhile for a seedy person to become an employee? If the daily wage rate is less than 1 unit of corn the seedy will want to be employers, not employees, because they can earn positive profits as employers without working at all. Moreover, for any wage rate less than 1 unit of corn per day the seedy are better off working for themselves using the capital intensive process since they get 1 unit of net corn per day they work for themselves. So unless the daily wage rate were higher than 1 unit of corn the seedy will not willingly become employees. On the other hand, for any wage rate higher than 1⁄6 unit of corn per day the seedless are better off becoming employees than they would be becoming either employers or working for themselves. If the daily wage rate, w, is greater than 1⁄6 the seedless would receive negative profits as employers since lacking seed corn they can only put their employees to work in the less productive labor intensive process. And if w is greater than 1⁄6 the seedless are better off working as someone else’s employee than they would be working for themselves since they only get 1⁄6 unit of corn under self-employment in the labor intensive process. Another way of summing up the situation is: For any w < 1⁄6 neither seedy nor seedless will be willing to be employees. Instead, everyone would want to be an employer. For any 1 ≤ w neither seedy nor seedless will

10.Employees also have to put up with being told how to do their work by their employers. But for now we are assuming that none of our 1000 people care whether they engage in self-managed or alienated labor.

52 The ABCs of Political Economy

be willing to be employers. Instead, everyone would want to be an employee. Since we define a labor market to be one in which people agree to be employers and employees voluntarily, only for 1⁄6 ≤ w < 1 would the labor market be used.

Consider some daily wage between 1⁄6 and 1, say w = 1⁄3. Would there be willing employers and willing employees at this wage rate? The seedless would not be willing to be employers since when w = 1⁄3 profits are negative for seedless employers who could only put their employees to work in the labor intensive process. But the seedy would gladly be employers since every day of labor a seedy person hired would yield her a profit of 2⁄3 units of corn. (One day of labor working with 1 unit of seed corn in the capital intensive process yields 2 units of corn, gross, and 1 unit of corn net, leaving 2⁄3 units profits after paying 1⁄3 units in wages.) None of the seedy would be willing to be employees for a daily wage of 1⁄3 units of corn since they can get 1 unit of corn per day of self-employment in the capital intensive process. But all the seedless would be willing to be employees since a daily wage of 1⁄3 is twice as much as the 1⁄6 per day they get by self-employment in the labor intensive process. As a matter of fact, for any 1⁄6 ≤ w < 1 all the seedy would be willing to be employers and all the seedless would be willing to be employees.

But this does not mean that any daily wage rate higher than 1⁄6 and lower than 1 could become the permanent, stable, or what economists call equilibrium wage in our economy. As a matter of fact, 1⁄3 is not an equilibrium wage. At w = 1⁄3 all 900 seedless people would want to work 3 days each as employees. That would be a total supply of labor of 900(3) = 2700 days. But the total demand for labor would only be 500 days. This is because while each seedless person would like to hire as many days of labor as possible since profits are positive at w = 1⁄3, profits are only positive if you put your employees to work in the capital intensive process, and each seedy person only has 5 units of capital, which is only sufficient to put 5 days of labor to work in the CIT. So the maximum possible demand for labor in our economy is 5 days of labor per seedy employer times 100 seedy employers, or 500 days of labor. So if w were equal to 1⁄3, the supply of labor (2700 days) would greatly exceed the demand for labor (500 days). In any market where excess supply prevails, all buyers will be able to buy all they want at the going price, but only some of the sellers will succeed in selling all they want to sell at the going price. There is an incentive for frustrated sellers, i.e. those who find they cannot sell all they would like to at the going price, to offer to sell

A Simple Corn Model 53

at a lower price in order to move from the group of frustrated sellers who could not find buyers to the group of satisfied sellers who do find buyers. But this will drive the price down.11 For any daily wage rate higher than 1⁄6 there will be excess supply in the labor market in our economy, and the self-interested behavior of seedless people who cannot get all the days of work they want, combined with the selfinterested behavior of seedy people who see that they could find willing employees at an even lower wage rate, will push the wage rate down. Presumably this would continue until the daily wage was 1⁄6, at which there would no longer be excess supply in the labor market. We have found the equilibrium wage for our economy. If we legalize a labor market there would be some people willing to become employees and some people willing to be their employers for any wage rate between 1⁄6 and 1. But for all wage rates higher than 1⁄6 there would be excess supply in the labor market which would push w down to 1⁄6 – the equilibrium daily wage rate.

At w = 1⁄6 what will each seedless person do? She will work 6 days and end up with 1 unit of corn to eat. Some may work all 6 days in the capital intensive process as employees. Some may work all 6 days for themselves in the labor intensive process. Some may be selfemployed for some days and employees for other days, but all of the seedless will work a total of 6 days each in any case.

At w = 1⁄6 what will each seedy person do? She will hire as many days of labor as she can put to work in the capital intensive process, i.e. 5 days of labor; 5 days of labor working with her 5 units of seed corn in the capital intensive process will produce 10 units of corn, gross, on Sunday. Five of the 10 units will be used to replace the 5 units used up.12 Since our seedy employer hired 5 days of labor at a daily wage rate of 1⁄6 she must pay (1⁄6)(5) = 0.833 units of corn in wages, leaving 5 – 0.833 = 4.167 units of corn in profits. Each seedy person consumes 1 unit out of her profits and therefore will be able to accumulate, or add to her stock of seed corn for the following

11.There is also an incentive for savvy buyers who notice there are more sellers than buyers at the going price to lower the price they are willing to pay. We study the logic of this micro law of supply and demand further in chapter 4.

12.We require replacement of seed corn used because we want to explore what economists call “reproducible solutions,” i.e. we want outcomes that could be repeated indefinitely, week after week.

54 The ABCs of Political Economy

week 3.167 units of corn, beginning the second week with 5 + 3.167 = 8.167 units of seed corn.

How has opening up a labor market affected the degree of inequality and efficiency of our economy? The maximum number of days anyone works is still 6. But now the minimum number of days worked is 0, giving a degree of inequality of 6 – 0 = 6 which is greater than 5 under autarky. In fact, opening the labor market has increased the degree of inequality in the economy by more than the difference between 6 and 5 would indicate. The seedless continue to work 6 days and consume 1 unit of corn. But the seedy not only reduce their work time from 1 day to 0 while continuing to consume 1 unit of corn, they each accumulate 3.167 units of corn as well while the seedless accumulate nothing. In other words, a more accurate measure of the degree of inequality in the economy which accounted for differences in accumulation would tell us that the degree of inequality had risen to something greater than the 6 indicated by our imperfect measure.

We calculate the efficiency of the economy as before, dividing the total number of days worked by total net corn production. The seedless work 900(6) days while the seedy work 100(0) days, or 5400 total days worked – 100 less than under autarky because the 100 seedy people no longer work 1 day each. But when counting total net corn production we have to remember that not all net corn produced got consumed this time. Some net corn produced gets consumed. As before, there are 1000 units of net corn consumed since each of the 1000 people consumes one each. But unlike under autarky, the seedy also accumulate corn when we legalize a labor market. Each seedy person accumulates 3.167 units of corn for a total of 100(3.167) = 316.7 units of corn accumulated. So the average number of days worked per unit of net corn produced is now [900(6) + 100(0)], or 5400 total days worked divided by [1000 + 316.7], or 1316.7 units of net corn = 4.101 as our measure of efficiency for the economy.

Credit market

What if wage slavery were made illegal – just as chattel slavery was abolished by law in the United States after the Civil War – but borrowing and lending seed corn were legalized? That is, what if instead of opening a labor market we open a credit market? What does it mean to open, or legalize a credit market, and under what circumstances would people use it? In our simple economy a credit market means that someone lends seed corn to someone else on

A Simple Corn Model 55

Monday morning and the borrower pays the lender back on Sunday not only the amount she borrowed on Monday, i.e. the principal, but some additional amount of corn in interest that the borrower and lender agree to. Are there weekly interest rates per unit of borrowed corn at which we would find some people willing to be lenders and other people willing to be borrowers? Is there an equilibrium weekly rate of interest, r, that we might expect to eventually prevail in our simple economy?

The first thing to consider is why anyone would ever want to be a borrower rather than a lender. After all, the lender gets back more than she lent and the borrower has to give back more than she borrowed! The reason to borrow in our economy is to avoid having to work in the less productive, labor intensive process for lack of seed corn. If I have a unit of seed corn I can get 1 unit of corn for a day of self-employed labor in the capital intensive process. Whereas, if I have no seed corn, a day of self-employment in the LIT only yields 1⁄6 unit of corn. As outrageous as a 5⁄6 or 83.3% weekly rate of interest may seem, for any r < 5⁄6 the seedless in our economy are better off borrowing seed corn at the beginning of the week and using it to work for themselves in the capital intensive process instead of working for themselves in the labor intensive process. If a seedless person borrows 1 unit of seed corn and works with it for a day she will get 2 units of corn on Sunday. She can use 1 of the 2 units to pay back the principal and still have 1 unit of corn, net, for 1 day of work. As long as the rate of interest is less than 5⁄6 she will still have more than 1⁄6 unit of corn left after paying interest as well as principal

– which is better than had she not borrowed at all and worked the day in the labor intensive process instead. So there will be plenty of willing seedless borrowers if r < 5⁄6. And it is not hard to imagine that the seedy will be willing to lend. As long as r > 0 the seedy do better for themselves by lending and collecting interest for no work on their part.13 So we will have willing (seedy) lenders and willing (seedless) borrowers for any 0 < r ≤ 5⁄6.

13.If the interest rate became low enough a seedy person would not want to lend out all 5 units of her seed corn. If the interest rate was so low she could not get 1 unit in interest for all 5 units lent, she should keep enough seed corn (something less than 1 unit out of her stock of 5) to do however much work she had to do herself in the capital intensive rather than the labor intensive process. However, we are about to discover that the equilibrium interest rate in our simple economy is high enough, by a considerable margin, to rid our seedy lenders of this technical worry.