I brought up the concept of the Super Macroeconomic Potential real GDP in a previous post, where I presented the basic model of Effective Demand.
Super macroeconomic potential real GDP is a long string of words to describe the TRUE output of the economy. That is right. We have our real GDP and our potential real GDP, but those only describe the value of what we are producing. The Super macroeconomic potential real GDP tells us if we could do better in terms of utilizing our capital and our labor. It is a broader measure of real output.
It is a measure that tells us if we are really living up to our TRUE potential.
The equation for SMPRGDP is...
Super macroeconomic potential real GDP = $3 trillion*(els*cu - 0.5*cu2)/els + Y*cu
els=effective labor share... cu=capacity utilization... $3 trillion is the amplitude constant of the business cycle in real 2005 dollars... Y is real GDP.
We may see that real GDP keeps rising through the years, but SMPRGDP has its own story to tell.
Let's look at a graph plotting real GDP and SMPRGDP since 1967.
We can see that before 1991, the economy was living up to its true potential as far as utilizing capital and labor. Before 1976, the economy was actually over-utilizing its capital and labor. The Reagan years were blessed to have hit the sweet spot in true potential. Then after 1991, the economy began to under-perform.
We can see that the true output of the economy took a big hit in the crisis. As of 4Q-2012, the economy still hasn't returned to its SMPRGDP value from before the crisis, even though real GDP has reached a new high.
This graph is a sign that the economy has fallen apart. And according to the equation for Super Macroeconomic Potential real GDP the cause is found in one of its variables... the ever lowering effective labor share.
Here is a graph of effective labor share since 1967...
We can see that labor share has been going down. And some may think it hasn't gone down by much. But when compare effective labor to the optimal effective labor share from the growth model of Effective demand, you really see the story behind effective labor share
The growth model shows that as real GDP increases over the years, so does the optimal balance where capacity utilization equals effective labor share. We see this increase in the optimal balance in the graph through the orange line.
The views of Milton Friedman grew out of the time when effective labor share was over the optimal balance. He saw the unions were asking for too much. He saw that the minimum wage was inefficient. He wanted a return to capital profits. He was right for those years. But he never realized that the economy would fundamentally change in the coming decades.
The optimal balance crossed actual effective labor share through the Reagan years; one reason why those years are honored for its economy. During the Reagan years, the economy was in the sweet spot. The views of Milton Friedman seemed to create balance in the economy. However, his views based on the 1960's were meant to lower labor share, and that is exactly what kept happening. Instead of increasing effective labor share as the optimal balance started to increase over actual effective labor share, we let it drop. We have not matured correctly economically.
Economists did not have this theory of Effective demand to know what was happening in the larger Super macroeconomic framework if you will. They used what they were taught from a time that had different economic dynamics.
This is a large part of the explanation for why our economy is under-performing and why unemployment is still high. We have to learn how to raise labor income share.
