Did you come across a production function without labor? Well that is not a far-fetched idea in developed economies where the majority of the output of the economy, which finally fructifies into new capital, does not require any additional input from the labor side.

 

As long as there is value in the exchange, created out of the belief that both sides of the transaction had a win-win, even in absence of any economic activity that involves labor, this could actually go through.

 

From Bitcoins to exchange traded funds, to financial products of all kinds, this is the case; labor & materials which were essential inputs to the production function (output function) ceases to exist.

 

It is like the “useless” Van Gogh paintings that were kept in Theo’s custody for decades, suddenly became very valuable and the exchanges thereafter created enormous value in every exchange.

 

First of all the developed world economies are doing exceedingly well to inch up in outlook and corporate profits are a great reminder that the tailwind will keep the sails intact in 2018.

 

Developed Economies continue to function with a balance between production function and finance as Minsky would have said. According to him the economy is never in balance but today this balance is getting disturbed by too much credit that cannot find useful production avenues in the economy and must therefore park as financial assets.

 

So it is somewhat like this that the capital formation does not have a useful production function to receive that capital as a feed. The feed-backing of capital into production, which was so far one of the useful avenues of capital ceases to be so.

 

But this would mean, there will be no need of additional labor into this existing production function, or let me rephrase this as “useful” labor; any amount of wasteful labor can be accumulated or inputted but the useful component ceases to attract any value in the function.

 

Well one of the reasons must be that there were cheaper sources of labor outside the country, so this had an economic sense but it reached a point that economists would be worried about the extreme consequences.

 

This scenario manifests itself in financialization and in products that move like asset classes, one competing against the other like commodities; it could be one exchange against the other, currency or stock, ferrous vs non-ferrous or oil.

 

Imagine that an airlines company has two uses of capital, one to buy more airplanes and the other to invest in stocks, including buying back its own stocks. If the return for the second is higher than the former, it would do so. In fact one could do better by creating a natural hedge between oil stocks and airlines stocks as during a shock in oil prices when one moves down the other normally moves up, so you are shock proof as well.

 

Holders of capital stock have a basket of options where to invest their capital as they have no effective consumption function where this could be utilized; the only avenue left is to trade in assets.

 

Asset prices have shown a mix of movements apart from housing, which has remained range bound till the economics of new housing starts to fail against the established tests of house price Vs rent, but other financial assets have moved way north. As it moves north more capital gets allocated in the same mix of assets. In earlier times it would have scared other participants but not now; the central banks have remained facilitators.

 

The collective belief that if an asset is good to invest in its price must provide the best information of how good it is, could well be up for scrutiny as we have seen some assets have demonstrated behavior of a bubble.

 

The credit leaking into the real economy has been stunted quite heavily and real production that needs labor has stunted as well; it is like thinking of a production function devoid of labor.

 

Raw material and labor have ceased to be the major inputs to the production function in the developed economies.

 

Developed economies have to prove that they can afford a production function where output grows without commensurate labor inputs, where capital remains fungible to fully preclude all innovation that translates into output that has far too less labor share.

 

This could well play out, poised between innovation and financial engineering, but that would also demand that innovation replaces all other inputs as feedstock for the economy; raw material and labor as inputs have withered.

 

This is the real challenge and 2018 could be a turning point for the developed world unless this puzzling question gets resolved.

 

Labor actually helped to buoy the demand side of the story, more labor inputs helped to create consumption in the economy from cars to white goods to more service sector requirements from leisure to travel.

 

Could this last longer than we would think or is there a tipping point? There is of course one, where central banks modulate the flow in not so predictable manner.

 

So far this flow has been predictable and if they said three times the rates will be changed, they actually ended up doing that.

 

The real tipping point is when the developing economies do not perform better, this is where no net labor is getting added in the equation. This has a very slim chance given the huge gap that exists, but for the engine of the world to be moved efficiently, much more attention is needed here.

 

But what if this changes and there are new head winds that we did not see?

 

This remains a new puzzle for the New year.

 

Production Function without Labor

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