There was a question about how investment affects labor share and capacity utilization. and why investment spending is not in the effective demand equation.
Well, investment is in the effective demand equation. As well as other variables...
look at this equation
ED = real GDP * e/T
e = effective labor share... T = TFUR, total factor utilization rate (employment rate * capital utilization rate)
Change to...
ED = (C + I + G + NX) * e/T
C = household consumption
I = net investment (investment - savings)
G = net government spending (government spending - taxes)
NX = net exports (exports - imports)
In this equation, any variable in (C + I + G + NX) can increase effective demand.
But it comes back to how they affect labor share and capacity utilization.
You could look at a country like China that has high NX and I... and low C. Ultimately, the limit on utilization of labor and capital is determined by e and T.
From today’s post on productivity, we can see how important utilization of labor is, because now growth in real GDP is completely dependent upon increasing labor hours since productivity is stalled.
The essential part to look at is that there are leakages and injections to the circular flow of the economy. Ultimately any leakage or injection multiplies through the circular flow at the ratio of labor income/capital income. Remember that the circular flow describes the domestic economy, which is the realm of real GDP. Thus effective demand also applies to the same realm that real GDP applies to. Leakages and injections to real GDP are also leakages and injections to effective demand.
Now investment is an injection into the circular flow. Quick search for definition.
“Injections in the circular flow of income, spending which is not generated by households, examples are investments, government spending and exports.
Leakages or withdrawals in the circular flow of income, spending by households which does not flow back into the domestic firms, examples are savings, taxes and imports.”
Leakages or withdrawals in the circular flow of income, spending by households which does not flow back into the domestic firms, examples are savings, taxes and imports.”
Investment is an injection that begins to multiply through the domestic economy, which is the realm of real GDP calculation. Investment multiplies through the economy at the labor income/capital income ratio. So any initial effect from investment to change labor share will get equalized out as the investment multiplies through the circular flow of real GDP.
Now savings is the leakage side of investment. Taxes are the leakage side of government spending, and imports are the leakage side of exports. But they all multiply through at the institutionalized ratio of labor to capital income. If any one of the variables can change the labor to capital income ratio, fine, but then all other variables will multiply through the circular flow at that new level too.
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