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Income distribution and investment. What Australia has to show to South America

This post is part of a series of posts that seeks to show some characteristics of the Australian economy that allows us to get some takeaways from the experience of such a strong resource-rich economy.

As it is usual in this blog, a comparison between Australia and some South American countries will be made. Mexico is included in the sample given its economic importance as a Latin American economy.

 

Capital accumulation and economic growth

The economic literature acknowledges capital accumulation as a key element of economic growth (Harrod, 1939; Domar, 1946; Kaldor, 1957, 1962) and historically the industrial revolutions played a central role in such growth (Murphy, Shleifer, & Vishny, 1989; chang, 2007, 2010). Thus, De Long & Summers (1991) found that the machinery and equipment investment has a strong association with economic growth and suggest that governments should not impede the import of capital goods.

Capital goods embody technology (Kaldor, 1962; De Long & Summers, 1992) and the economic growth and development requires an increasing capital stock that only can be brought about by investment. In this order of ideas, a key characteristic of fast-growth economies is the high investment rates. For instance, a big difference between South American and East Asian countries lies in the relatively high investment rates above 30% as a share of GDP sustained over time in the latter ones.

In the context of resource-rich economies, the investment rates also stand out as a feature that distinguishes Australia from South American countries (see A brief comparison of Australia and South American countries as resource rich-economies), and it also can be seen in the agricultural sector (Some differences between the agricultural sector of Australia, New Zealand, and South America ).

 

Are bigger profits being invested?

As a result of the production process, a magnitude of value is created and takes the form of income that is distributed between the capitalists and workers in the form of profits and wages, respectively.

By principle, the investment depends on the profits the capitalists can get, not only because more surplus means more resources to invest, but because profits are the driver of capitalist society (Marx, 1867). As it is stated in Kaldor (1961):

investment and accumulation presuppose that the rate of profit is high enough (in the words of Ricardo) to afford more than the minimum necessary compensation to the capitalists ‘for their trouble, for the risk which they must necessarily encounter in employing their capital productively‘ (p.189).

However, it is noteworthy to mention that capitalists can decide not to invest their profits or invest a relatively small share of them despite making profits because the Investment is a very unstable variable that does not depend only on profits but also on expectations (decisions of human beings are hard to predict).

As investment is the task of the “capitalist class” in the society (Lewis, 1954) and if they are getting overtime a bigger portion of GDP in the form of profits, we can expect that the investment rate as a percentage of GDP should also be bigger over time, after all the capitalists are getting profits. In other words, high inequality (more money in the hands of capitalists) should be accompanied by more investment

Let’s see the data about inequality. In South American countries the Gini is higher (more unequal societies) than the East Asian countries and Australia. Remember that «a Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality» (see world bank data here).

Figure 1. Average Gini index 1980-2019 selected countries

Source: graph made with data from The World Bank

However, the investment rates of South American countries are much lower than the East Asian countries, which have held investment rates above 30% of GDP sustained over decades. (The South American economies’ external constraints: a comparison with Australia and East Asian countries).

Latin American countries did not achieve the threshold of 30% of GDP, with the exception of Venezuela. However, this country is an oil exporter that did not diversify its productive matrix and could not sustain the high levels of investment after 1980 and fell dramatically.  

Table 1. Investment rate as a percentage of GDP

Source: own calculations with data from Feenstra, Inklaar and Timmer (2015).

More inequality has not translated into more investment and thus, we have societies in the worst of both worlds in South America; a very unequal society without fast economic growth. In other words, more resources in the pocket of relatively few people are not going to more productive investment to grow.

 

What about Australia?

Australia does not have a diversified external sector, most of its exports are made up of raw materials from natural resources (the Observatory Economic Complexity). One could argue that that country is in the same situation as Venezuela. However, historically it has been a more equal society than the Latin American countries (McLean, 2013) and up to date, Australia keeps relatively low inequality (figure 1).

In Australia, the capitalists play their role as a class that invests, judging by the relatively high investment rates since the 1950s (see the rates in the post A brief comparison of Australia and South American countries as resource rich-economies).

If we take the Australian investment per worker as a benchmark and compare it with the one held by the South American countries, we will see that each of these economies fell far behind the Australian marks from 1950 to 2017.

The exception is Venezuela that in the 50s and 70s reached the level of investment per worker that Australia held. Nevertheless, Venezuela could not maintain a relatively high level of investment rates per worker and Australia could.

Table 2. Investment per worker as a percentage of Australian investment per worker

Source: own calculations with data from Feenstra, Inklaar and Timmer (2015).

In general, in South America, the investment has been far below the Australian levels.

Although in some South American countries the investment per worker has increased as a share of the Australian investment per worker, it remained low and even has fallen in Colombia, Ecuador, Mexico, Paraguay, and Venezuela.

Chile stands out among the South American economies, but on average between 2010 and 2017, the investment per worker barely approach 50% of Australia’s. Keep in mind that Latin America is told that Chile is a successful case thanks to orthodox-market friendly policies.

 

In the absence of Investment, the way out is devaluation

As already have seen, the investment rates have been relatively low throughout the time, thus the labor productivity is relatively low. That is to say, the South  American economies do not count on enough capital goods technologically sufficient to compete in the global market with the industrialized economies.

The only way a country can cope with its worldwide competitors without investing enough is through devaluation. In other words, lowing the cost of its manpower in international terms. It is the way how the capitalists in the developing world compete in the international field.

We can see in table 2 that all the South American currencies have depreciated significantly. Differently has been the behavior of the Australian Dollar and the East Asian countries taken in the sample.

Table 3. Average devaluation (Official exchange rate: national currency per American dollar)

Source: graph made with data from The World Bank

We have seen that historically Australia has invested much more than all the Latin American countries measured by the rate of investment to GDP and by investment per worker, thus, it is not forced to compete through devaluations in the international markets.

A central question can be raised: Why do capitalists invest more in Australia than in South America? However, the answer to this question is beyond the range of this post.

 

Takeaways

Inequality has been relatively high in Latin American countries and investment rates throughout the time have been relatively low in Latin American countries. That is to say, the South American countries have a model where the income is concentrated in a few hands and such an income does not go back to the economy as an investment to ample the productive capacity. Business people in South America do not perform their tasks in the system as the capitalist class.

The Latin American countries as developing economies with backward technic-scientific economic apparatus compete in the world market through devaluation instead through investment and capital formation that boost productivity gains. In other words, they compete impoverishing their labor force in terms of foreign currency. 

 

References

Chang, H. (2010). 23 Things They don’t Tell You about Capitalism. Londres: Penguin Books.

Chang, Ha Joo (Ed.) (2007) BadSamaritants: The Myth of Free Trade and the Secret History of Capitalism. Londres, Reino Unido: Bloomsbury Press, 254 p.

De Long, B., Summers, L.H., 1991. Equipment investment and economic growth. Quarterly Journal of Economics 106 (2), 445–502.

Domar, Evsey D.  Capital Expansion, Rate of Growth, and Employment. conometrica, Vol. 14, No. 2 (Apr., 1946), pp. 137-147

Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer (2015), «The Next Generation of the Penn World Table» American Economic Review, 105(10), 3150-3182.

Harrod, R. F.  An Essay in Dynamic Theory. The Economic Journal, Vol. 49, No. 193 (Mar., 1939), pp. 14-33

Kaldor, Nicholas (1962). Capital Accumulation and Economic Growth. Cambridge REPRINTED FROM THE THEORY OF CAPITAL MA9MILLAN & CO LTD

Kaldor, Nicholas. A Model of Economic Growth. The Economic Journal, Vol. 67, No. 268 (Dec., 1957), pp. 591-624

Kevin M. Murphy, Andrei Shleifer, Robert W. Vishny. The Journal of Political Economy, Volume 97, Issue 5 (Oct., 1989), 1003-1026.

Lewis, W. A. (1954) Economic Development with Unlimited Supplies of Labour

Marx, Carlos (1867). El capital: crítica de la economía política (vol. I). Ciudad de México, México: Fondo de Cultura Económica, 769 p.

McLean, Ian W. 2013. Why Australia Prospered: The Shifting Resources of Economic Growth. Princeton University Press: United States of America. P.281.

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Medardo Alfonso Palomino Arias

Por Medardo Alfonso Palomino Arias

Economista y Magister en Gestión Pública graduado en la Universidad Santiago de Cali, Colombia. He sido Profesor desde el año 2014 en distintas universidades de Cali. En la actualidad me encuentro adelantando estudios y viajando en Australia. El proposito de mi blog es difundir conocimiento sobre economía y brindar un espacio para el debate.

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