CHAPTER

35
The Kaldor Model of Distribution Kaldor Distribution
THE KALDOR MODEL
The Kaldor model1 is an attempt to make the saving-income ratio a variable in the growth process. It is based on the classical saving function which implies that saving equals the ratio of profits to national income, i.e., S = P/Y. Assumptions. Kaldor builds his model on the following assumptions: (1) There is a state of full employment so that total output or income (Y) is given. (2) National income or output consists of wages (W) and profits (P) only. W comprises both manual labour and salaries, while P includes the income of property owners and of entrepreneurs. (3) The marginal propensity to consume of workers is greater than that of capitalists whereby the marginal propensity to save of the workers, sw, is small in relation to those of capitalists sp, i.e., sp>sw. (4) The inyestment-output ratio (I/Y) is an independent variable. (5) Elements of imperfect competition or monopoly power exist.

1. N. Kaldor, Essays on Value and Distribution, 1960, pp. 227-36.

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THE MODEL Given these assumptions and taking Sw as aggregate savings out of wages and Sp as aggregate savings out of profits, we have Y=W+P ....(1) W=YP But I=S ...(2) and S = Sw + Sp ...(3) Investment being given and assuming simple proportional savings functions, Sw=swW and Sp=spP, we obtain the equation S = spP+swW ...(4) Dividing equation (4) by Y, we have S P W = sp + sw Y Y Y I P W = sp + sw (Q S = I ) Y Y Y Put the value of W = (Y P) in (6) I P YP = sp + sw Y Y Y or or or or I P P = sp sw + sw Y Y Y I P = (sp sw) + sw Y Y P I (sp sw) = sw Y Y ...(8) ...(5) ...(6)

...(7)

P I 1 sw = . Y Y sp sw sp sw Thus, given the marginal propensities to save of the wage-earners and the capitalists, the share of profits in national income depends on the ratio of investment to the total output. If there is an increase in investmentincome ratio I/Y, it will result in an increase in the share of profits to national income P/Y; so long as sp>sw. This is illustrated in Fig. 1. Given the full employment level of income Y0 , the saving-income ratio and the investment-income ratio are S/Y0 and I/Y0 respectively. The economy is in full employment equilibrium at point E with a fixed profitincome ratio given by the vertical line PP. If there is an increase in income, the S/Y0 and I/Y0 functions shift upward to S/Yl and I/Yl at point F. But the share of profits

I/Y, S/Y

F E

S/Y1 S/Y0 E1 I/Y1 I/Y0

P Fig. 1

P/Y

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in national income remains constant as given by the line PP. In case I/Y0 alone shifts up to I/Y, the saving-income function remaining at S/Y0 level, there would be inflationary rise of prices. This would raise the profit-income ratio and thus push up the saving-income function to S/Yl with equilibrium at point F. If such a relation continues between the I/Yand S/Y functions, the economy will maintain itself at the full employment level at the line PP and P/Y will remain constant. The interpretative value of this model, according to Kaldor, depends on treating investment, or rather the ratio of investment to output I/Y as an independent variable, invariant with respect to changes in sp and sw. This, along with the assumption of full employment, shows that the level of prices in relation of the level of money wages is determined by demand. An increase in the level of investment would raise the level of demand and prices. Consequently, the share of profits in national income would rise, but reduce real consumption. Contrariwise, a fall in investment will reduce total demand, bring a fall in prices and profit margins but increase real consumption. Assuming flexible prices (or rather flexible profit margins) the system is thus stable at full employment. As already pointed out, this model operates when the two savings propensities differ, sp sw. sp>sw is the stability condition. If sp is less than sw, a fall in prices would cause a fall in demand and to a cumulative fall in prices. Similarly, a rise in prices would be cumulative. Further, the degree of stability of the system is dependent upon the difference between the marginal propensities to save, on 1/(spsw) which Kaldor defines as the coefficient of sensitivity of income distribution. If there is a small difference between the two marginal propensities (sp and sw), the coefficient (l/spsw) will be large and small changes in the investment-output ratio (I/Y) will lead to relatively large changes in income distribution (P/Y) and vice versa. In case the marginal propensity to save from wages is zero (sw = O); the amount of profits is equal to the sum of investment and capitalist consumption, 2 i.e., P =
1 I . This is widows cruse sp

where a rise in the consumption of entrepreneurs raises their total profit by an exactly equal amount:3 If however I/Yand sp are assumed to be constant over time, the share of wages will also be constant. In other words, as output per man increases real wages will rise automatically. In case the propensity to save out of wages, sw is positive (sw>0) , total profits will fall by Sw (the amount of workers savings). When the workers savings are reduced, total profits rise by a greater amount than the change in investment, and vice versa. Assuming the investment-output ratio (I/Y) to be an independent variable, its determinants can be described in the Harrodian terminology in terms of the rate of growth of output capacity (G) and the capital-output ratio (v):
I Gv * ...(9) Y In a state of continuous full employment, G must equal Harrods natural rate of growth Gn. For Harrods equation of warranted rate of growth I/Y=s we can substitute equation (8) above:

2. Capitalist consumption is shown as 1/sp, just as in the Keynesian analysis marginal propensity to consume is 1/MPS. 3. Cf. J.M. Keynes, Treatise on Money, Vol. I, p. 139 * Kaldors Gv is Harrods Gw. Cr.

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or or and

P I 1 sw = . Y Y sp sw sp sw
P 1 I = . Y sp Y

sw = 0]

I = Gv = Gw. Cr Y
P 1 = . Gw. Cr Y sp

[From (9)]

Kaldor concludes: Hence the warranted and the natural rates of growth are not independent of one another; if profit margins are flexible, the former will adjust itself to the latter through a consequential change in P/Y. However, Kaldor points out that there will not be an inherent tendency to a smooth rate of growth in a capitalist economy. In fact, the causes of cyclical movements are found in disharmony between the warranted and the natural growth rates. To Kaldors basic equation (8) may be added two restrictions, i.e., sw<I/Y, and sp>I/Y. Restriction sw<I/Y excludes the case of a dynamic equilibrium with a negative share of profits, and sp>I/Y excludes the case of a dynamic equilibrium with a negative share of wages. If the former restrictions were not satisfied, the system would enter into a state of chronic underdevelopment. Similarly if the latter were not satisfied, the system would enter into a state of chronic inflation. The Kaldor model is meant to operate within these limits and shows how a distribution of income and a rate of profit through time will help the system in equilibrium. ITS CRITICISMS The kaldor model of distribution has been criticised on the following grounds. 1. The model shows that the share of profits to income P/Y, the rate of profit on investment, and the real wage rate are functions of I/Y which, in turn, is determined independently of P/Y or the real wage rate. But this is true only under certain conditions. First, the real wage rate cannot be below a certain minimum subsistence rate. Second, the share of profits cannot fall below the risk premium rate, which is the minimum profit rate necessary for inducing capitalists to invest. Third, the share of profits cannot be below the degree of monopoly rate, i.e., a minimum rate of profit on turnover due to imperfect competition, collusive agreements, etc. The second and third being alternative limitations, the higher of the two will apply. Lastly, the capitaloutput ratio should be independent of the rate of profit. Otherwise I/Y will be itself dependent on the rate of profit. If these conditions are satisfied, there will be an inherent tendency to growth and to a state of full employment. However, in the short run the shares of profits and wages tend to be constant due to the downturn inflexibility of P/Y and the real wage rate, as a consequence of the constancy of I/Y. 2. Another weakness of the Kaldor model is that it attributes all profits to the capitalists and in this way it implies that workers savings are totally transferred as a gift to the capitalists. This is clearly absurd, for under such a condition no individual would save at all. 3. The Kaldor model neglects the impact of technical progress on income distribution. Even

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assuming that workers do not save out of wages (sw=0), it is not possible to raise the total profits of entrepreneurs by an exactly equal amount through Widows Cruse. It is in fact technical progress which helps in increasing profits. 4. According to Meade, Kaldors theory of distribution is more appropriate for the explanation of short-run inflation than of long-run growth. 5. Like all contemporary theoretical models of economic growth, it assumes a production function that does not allow any substitution between factors. Thus it presents a rigid and angular picture of the economic progress. 6. Jan Pen has argued that when the investment-income ratio I/Y increases, the entrepreneurs become optimist because the share of profits increases. Given sw and sp, the entrepreneurs reinvest their profits. As a result, I/Y increases further, and so do profits. In this way, there may be an infinite expansion of the economy. But this is not possible in actuality. Rather, a continuing rise of the investment-income ratio I/Y is likely to lead to overspending , wage inflation, and a wage-price spiral which in fact determine income distribution. The Kaldorian theory is weak in that it does not discuss these consequences of an increase in I/Y. 4 7. Kaldors theory of income distribution is unrealistic because it does not take into consideration human capital which plays an important role in determining distributive shares in national Income. The theory states that with the rise in I/Y, the share of profits in national Income increases but the share of wages falls. As a result of the decline in the share of labour, the condition of the wage earners will deteriorate. This will, in turn, reduce the economys real income and output. Thus, in the words of McCormick, The failure of the theory to incorporate human capital leaves the theory too simple to explain the complexities of the real world.5 Conclusion. To conclude with Prof. Sen: The Kaldor model of distribution is based on a number of restrictive assumptions... It is not easy to marry this macro-model to assumptions of individual behavior, and to combine it with attempted profit maximization requires that: (a) expectations be unfulfilled, which may be all right, but also that (b) this should lead to no feedback in entrepreneurial decision making , which is not so all right. .. what is less clear is whether the Kaldor model provides a satisfactory alternative or involves a jump from the frying pan to the fire.6

4. Jan Pen, Income Distribution, 1971. 5. B.J. McCormick, Wages, 1969. 6. Amartya Sen, Growth Economics, 1970