At the heart of every equation for Effective Demand and even the equations I haven't posted yet on this blog is the equation for effective labor share. So, what is effective labor share?
- It is a % value determined from actual data by plotting capacity utilization rates with the labor share of income published by the Bureau of Labor Statistics.
- The equation for effective labor share is... effective labor share = 0.78 * labor share: Business sector (2005=100). One takes the number published by the Bureau of Labor Statistics and multiplies it by 0.78.
- The equation for effective labor share shows the central tendency of the relationship between labor share of income and capacity utilization with a y-intercept of zero. The implication is that as labor share goes to zero, there would be no income for consumption of production. Thus, effective labor share influences the rate of capital utilization.
- Effective labor share thus establishes the limits/constraints upon the utilization of capital and ultimately labor. The implication is that as labor share goes down, so too must utilization of capital go down at a corresponding rate due to diminishing demand from lower labor income.
- Effective labor share is a % value that effectively establishes the aggregate demand capable of limiting production. Production could go above the limit established by effective labor share, but there are economic dynamics that work contrary to this situation. The resulting over-supply is not profitable, nor efficient, and thus not common.
- Effective labor share is the hypothetical upper limit of the rate of capital utilization as if there were 0% unemployment. The implication is that if everyone in the Labor Force is employed, labor share of income directly establishes the upper limit of the utilization rate of capital.
- Once there is unemployment, the utilization of capital can be increased beyond the limit set by the effective labor share to achieve the production allowed by effective aggregate demand. The implication is that the decreased utilization of labor (existence of unemployment) is compensated for by the increased utilization of capital, but still within the limits of Effective Demand, the point at which aggregate supply/production will not go above effective aggregate demand.
- Thus, effective labor share establishes the upper limit upon the combined utilization of BOTH labor and capital. The combined rate I call the Total Factor utilization rate, TFUR. The TFUR of both labor and capital is determined by multiplying their rates together. For example, 80% capacity utilization and 95% utilization of labor (5% unemployment) result in a Total Factor utilization rate of 76% (0.80 * 0.95). The TFUR is then measured against the rate of effective labor share (effective in limiting production). The total factor utilization rate (TFUR) of production can go below the effective labor share, but not above it. Thus, as effective labor share falls, it effectively pushes down the TFUR. The UT index (see data at right of this blog) measures the difference between effective labor share and the TFUR. The UT index has a zero lower bound that corresponds to the upper limit of the TFUR.
- Effective labor share implies a value for consumption of production, whereas its opposite, effective capital share implies a value for maintaining the means of production. The implication is that there might be a ratio between effective labor share and effective capital share that optimizes efficiency and equity in the economy. I will post at a later date the model that establishes a range for that optimum ratio.
- Effective labor share can be used effectively as the exponent in the Cobb-Douglas production function.
- At a later date, I will post my growth model of effective labor share. Basically, as an economy matures, the efficiency level of effective labor share slowly rises.
- The effective labor share establishes the center point of the business cycle. Capital utilization will rise and fall around its value. Thus it can be used to determine potential real GDP and a natural rate of unemployment for the center of the business cycle. I will post about these at a later date.
- Since effective labor share can be used to determine potential real GDP, it can be used in the Taylor Rule. I will post about this at a later date.