Some remarks on the standard basic (zero) growth model: the Solow –

The basic growth model of orthodox economic theory is the Solow model.

The Solow model supposes that the production function is first-order homo-geneous.⁷⁵ Therefore, income is integrally distributed among the “factors of production”, namely between capital and labour, where the term capital stands for the means of production.⁷⁶

Hence, in such a model setting, firms have never retained earnings. Only consumers have saving decisions; therefore, investment is the result of the preference between the present and future consumption. In these models, one

72 Soros György (1997): The Capitalist Threat. Atlantic Monthly. 279/2. 4

73 Taleb, Nassim (2012): Antifragile: things that gain from disorder. Random House. 431

74 Romer, Paul (2016): The Trouble With Macroeconomics. https://paulromer.net/trouble-with-macroeconomics-update/WP-Trouble.pdf (2020. 02. 14.)

75 If all factors of production are increased proportionally, production also increases proportionally.

Formally, the production function y=F(K,N), where y is the output, K is capital and N is labor, is homogeneous in first degree if for all a>1, ay=F(aK,aN).

76 Kt=Kt-1+It-At, where It is investment in period t, At is depreciation in period t. Investment is spend-ing in monetary terms. The translation of a monetary magnitude into real terms is not without diffi-culties (see 1.7 below). Orthodox models argue in real terms. Accounting approaches argue in mon-etary terms. Real terms are not directly observable; monmon-etary magnitudes (payments) are directly observable.

can obtain any result (s)he wishes: zero growth or growth depends on the exogenously given preferences.⁷⁷

As firms do not have investment decisions in these models, savings deter-mine investments and not the other way around. For a long time, we all know that in a monetary production economy, the logical chain is in the other way around, as explained, for example by Kalecki⁷⁸ or by Keynes (see widow’s cruse or paradox of thrift). Hence, by construction orthodox models cannot describe monetary production economies.

Even if left implicit, in orthodox models, firms are supposed to seek profits (maximal or not has no importance for us here). The profit objective is fully compatible with zero net saving. This said, there is no need for growth so that each economic agent be able to fulfill its plan; there is no growth imper-ative even if we observe growth.

2.7. Growth in monetary terms or in real terms?

As it is clear from the Solow model, orthodox economics thinks in real terms:

money, if at all, is added afterward. This procedure is clearly a logical non-sense: the functioning of an economy with money can be understood by ex-amining the functioning of an economy without money only if money is in-essential (M. Friedman) or neutral (R. Lucas). However, in that case, there is no need to integrate money into the model. Some non-orthodox economists believe that a monetary production economy (market economy) is different from an economy without money. Therefore, they depart from the existence of money. However, most of the adepts of this heterodox thinking integrate the production function into their models in order to get real magnitudes.

They generally make the mistake that in a national accounting (monetary flow) framework, investments also refer primarily to money flows and not to means of production: the passage between nominal and real variables is not underpinned theoretically.

Though the passage between nominal and real variables is generally consid-ered as a simple mechanical calculus, the transformation between these mag-nitudes is far from being without difficulties, because we should aggregate different products into one magnitude that represent somehow “physical”

77 This choice is left implicit in the exogenously given savings rates. The aim of internalizing the saving decision by considering the agents’ intertemporal choice gave rise to the proliferation of more sophisticated orthodox growth models. The point here is that the net saving rate can be set both to zero or to strictly positive values.

78 „Capitalist earn what they spend and workers spend what they earn.”

quantities. According to the general solution, instead of the genuine money flows, i.e. instead of the GDP measured at the genuine prices, the GDP is calculated with the prices of a fixed period. The first measurement is called GDP measured at current prices or nominal prices, and the latter measure-ment is called GDP measured at a base price or real price. The reference period is called the base period. If in a period the price of the same commod-ity bundle is p times higher than the price of this same bundle in the base period, then we call p price level, p-1 inflation if it is positive and deflation if it is negative.

From this passage between nominal and real variables, it is clear that differ-ent commodity bundle choices will generally result in differdiffer-ent price levels.

For example, the commodity bundle that represents the total use of products (Y) is probably different from the composition of the consumption goods (C) and of the investment goods (I). Therefore, the price index calculated on the basis of the composition of the commodity bundle that represents the total product will not reflect the evolution of the composition of the GDP in real terms. If the composition changes – and it changes except for the beloved proportional path – then it is not at all sure that the employment or the con-sumption of non-renewable resources increases if the GDP in real terms in-creases. For this eventuality, it is enough that the less labour-intensive pro-duction increase or the propro-duction that does not use non-renewable resources.

In brief, the aggregated production functions taken by analogy from the mi-croeconomics textbooks’ single firms’ production function used in the mac-roeconomic models are dubious.

In order to illustrate these difficulties, consider one single consumption good and one single investment good, which are different from each other. Hence, there is no problem of measuring the production in physical quantities and the composition of the consumption and investment goods are completely different. Consider the base period 0 and the subsequent period 1 in three different scenarios:

data PCCreal + PIIreal = GDPnom

period PC PI Cfiz Ifiz Cnom Inom GDPnom P GDPreal

0 2 3 100 30 200 90 290 1 290

1_1 3 2 100 30 300 60 360 1,24 290

1_2 3 2 200 60 600 120 720 1,24 580

1_3 2 3 200 60 400 180 580 1,00 580

Nominal variables transformed Into real variables

Ratios

period Creal Ireal GDPreal Cfiz/Ifiz Creal/Ireal

0 200 90 290 3,33 2,22

1_1 241,67 48,33 290 3,33 5,00

1_2 483,33 96,67 580 3,33 5,00

1_3 400,00 180,00 580 3,33 2,22

In the base period, real and nominal GDP, as well as the real and nominal consumption and investments by definition, coincide. We can observe that the consumption in real terms (200$0) does not coincide with the consump-tion measured in physical terms (100kg), and the ratio of the consumpconsump-tion and investment in real terms (100/45, no unit) is different from the same ratio measured in physical quantities (100/30 kg/liter) because the real variables are influenced by the base period relative prices. For this reason, a propor-tional growth measured in physical terms (1_2; or the special case of zero growth: 1_1) changes the ratio of consumption and investment in real terms if relative prices change.

This said, the existence of a growth imperative in nominal terms in itself does not necessarily impede the ecological sustainability of an economic system, because nominal growth does not necessarily imply real growth (though this seems to be the general case) and real growth is also possible with structural change (again empirical evidence shows that this change is not sufficient).