The Suntory and Toyota International Centres for Economics and Related Disciplines

Productivity and Growth in Manufacturing Industry: A Reply

Author(s): Nicholas Kaldor
Source: Economica, New Series, Vol. 35, No. 140 (Nov., 1968), pp. 385-391
Published by: Wiley on behalf of The London School of Economics and Political Science and The
Suntory and Toyota International Centres for Economics and Related Disciplines

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1968]

Productivity and Growth in Manufacturing

Industry: A Reply
By NICHOLAS KALDOR
Professor Wolfe attacks me (in the May, 1968 issue of Economica)for
being obscure and unconvincing in the inaugural lecture which I gave
at Cambridge.1In this lecture I attempted to put forward a complex
thesis concerning the causes of high and low rates of economic growth
under capitalism, and this was necessarily somewhat scanty; there is a
limit to the material one can pack into a single lecture. Such a treatment
could only be successful if received with imagination and some goodwill;
Professor Wolfe has picked on a large number of individual points
(many of them trivial in substance) without attempting to come to
grips with the thesis as a whole. I propose to publish a more comprehensive statement of the theory in due course.2 Meanwhile rather than
follow the negative approach of answering each point in turn-which
would be both tedious and unconstructive-I shall concentrate on the
main points which have clearly not been understood.
Foremost among these is my notion of "economic maturity". This is
not some vague notion which can be defined in terms of "a situation in
which there is relatively small employment in agriculture".In my lecture
I defined it explicitly "as a state of affairs where real income per head
had reached broadly the same level in the different sectors of the
economy". I could have added, to convey its significance better, that
''economic maturity" could also be defined as "the end of the dual
economy"; or a situation in which "surplus labour" is exhausted; or one
in which "growth with unlimited supplies of labour" (to use Arthur
Lewis' phrase) is no longer possible.
The neo-classical framework of thought cannot accommodate notions like "disguised unemployment", the "dual economy", or the
distinction between "capitalist" and "pre-capitalist" enterprise. For
neo-classical theory assumes that the structure of demand determines
the distribution of resources between different uses; that competition
and mobility assures that "factor prices" tend to equality in all employments; that profit maximization ensures equality of factor prices with
the value of the marginal products of factors; subject only to friction
1 J. N. Wolfe, "Productivity and Growth in Manufacturing Industry: Some
Reflections on Professor Kaldor's Inaugural Lecture", Economica,vol. XXXV
(1968), pp. 117-26; N. Kaldor, Causesof the Slow Rate of EconomicGrowthof the
UnitedKingdom,CambridgeUniversity Press, 1966.
2 A somewhat more extended exposition was given in three lectures (subsequently published) at Cornell University: cf. Strategic Factors in Economic
Development,Ithaca, New York, 1967.
385

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386

ECONOMICA

[NOVEMBER

etc., each "factor" will tend to be used where is makes the greatest
contribution to the national product.
It would be generally agreed that these assumptions are at their most
inappropriatein the case of an under-developedcountry, or a country in
the earlier stages of industrialization. In such countries high and low
earnings sectors exist side by side; there are vast amounts of "surplus
labour" or "disguised unemployment" in the low-productivity sectors,
so that labour can be withdrawn from them without adverse effects on
the output of those sectors; and the supply of labour in the highproductivity, high-earningssector is continually in excess of the demand,
so that the rate of labour-transferencefrom the low to the high productivity sectors is governed only by the rate of growth of the demand for
labour in the latter. In fact the size of the labour force in the nonindustrial sector is a residual-entirely determined by the total supply of
labour on the one hand and the requirementsfor labour in the industrial
sector on the other hand. The best definition I could suggest for the
existence of "labour surplus" in this sense is one which is analogous to
Keynes' definition of "involuntary unemployment": a situation of
"labour surplus" exists when a faster rate of increase in the demand for
labour in the high-productivity sectors induces a faster rate of labourtransferenceeven when it is attended by a reduction,and not an increase,
in the earnings-differentialbetween the differentsectors.
For reasons that I explained in my lecture, the rate of growth of
industrialization fundamentally depends on the exogenous components
of demand (a set of forces extending far beyond the income elasticities
of demand for manufactured goods). The higher the rate of growth of
industrial output which these demand conditions permit, the faster will
be the rate at which labour is transferredfrom the surplus-sectorsto the
high productivity sectors. It is my contention that it is the rate at which
this transfertakes place which determinesthe growth rate of productivity
of the economy as a whole. The mechanism by which this happens is
only to a minor extent dependent on the absolute differencesin the levels
of output per head between the labour-absorbingsectors and the surpluslabour sectors. The major part of the mechanism consists of the fact that
the growthof productivity is acceleratedas a result of the transferat both
ends-both at the gaining-end and at the losing-end; in the first, because,
as a result of increasing returns, productivity in industry will increase
faster, the faster output expands; in the second because when the
surplus-sectors lose labour, the productivity of the remainder of the
working population is bound to rise.'
In the literature, the "surplus labour sector" is generally thought of
is by itselfcapableof explain'Indeed,theexistenceof disguisedunemployment
ing theseresults,even in the absenceof increasingreturns,sincethe increasein
will be a net additionto
industrialoutput,broughtaboutby labourtransference,

the GNP-there will be no compensating reduction in output elsewhere. As a

matterof historical fact, I am convinced,however, that the growth of productivity
resulting from increasing returns (both internal and external) has been a very
important part of the picture. (On this see below.)

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1968]

PRODUCTIVITY/GROWTHIN MANUFACTURINGINDUSTRY

387

as agriculture. This is because in the early stages of capitalist development much the greaterpart of the population draws its living from agriculture. However, disguised unemployment in "services"had been just
as prevalent-in Victorian England (as in present-day India or Latin
America) there were vast numbers of people who eked out a living in
urban areas as hawkers, petty tradesmen, servants, etc. on very low
earnings.' In the field of services however (unlike in agriculture) there
are two contrary processes at work: on the one hand industrialization
absorbs labour from services on a large scale; on the other hand, the
growth of industry itself gives rise to the growth of services of various
kinds which are both complementary and ancillary to industrial
activities (by "ancillary" I mean that the demand for these services,
e.g. transport, distribution, accountancy, banking services, etc. are
derived from, but cannot generate, industrial activities). As a result the
total employment in services tends to rise during the process of industrialization though less (in relation to the growth of total output) when
the growth in total output is relatively fast.
While it has long been known that labour has no "opportunity cost"
in an under-developed country-the absorption of labour through the
growth of industry involving no reduction in output elsewhere-it has
not been generally recognized that the same applies to most of the socalled "advanced countries" with relatively high incomes per head.
The view that growth rates, even in advanced countries, are dependent
on the rate at which labour is transferredinto manufacturingfrom other
sectors would find confirmation, in the first place, if over-all growth
rates are positively associated with rates of increase in employment in
manufacturing.
This is shown for the group of twelve advanced countries given in
Table 3 of my lecture for the period 1953/4-1963/4 by the following :2
(1)

6 =2-665+ 1-066,M

R2=.828

(015)
where G is the rate of growth of GDP and PM is the rate of growth of
employment in manufacturing.
This result confirms my general hypothesis unless it could be shown
that growth rates in manufacturing employment are themselves closely
related to growth rates of total employment so that the former could be
regarded as a proxy for the latter. Such positive association seems
1 This relates to both "self-employed"and employees alike. In the population
Census of 1891, 15-8per cent. of the occupied population of Britainwere classified
as domestic servants. In the Census of 1961 the figure was 14 per cent. This
reductioncannot be explainedin terms of a shift in consumerpreferencesor by the
assumption that domestic service is an "inferior good" with a negative incomeelasticityof demand; it can only be explainedby the growingabsorptionof surplus
labour in the economy which resulted in a rise in wages in domestic service which
was much in excess of the general rise in wages.
2 The sources for this and the following equations are given in the statistical
tables of my lecture.

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388

[NOVEMBER

ECONOMICA

ruled out, however, by the fact that there is no association at all between
rates of growth of GDP and rates of growth of total employment:
(2)

G=4-421 +O043lEg
(0.994)

R2=*018

whereEg is the rate of growthof total employment.

The positive correlation in Eq. (1) could only be consistent with the
absence of any correlation in Eq. (2) if rates of growth in over-all
productivity are positively associated with rates of growth of employment in manufacturingand negativelyassociated with rates of growth of
employment outside manufacturing. This is duly confirmed by the
following three equations:
(3)

Pg= 1868 +0991

EM

R2= 677

(0-216)
(4)

Pg= 4 924 -1

8OONM

R2-= 427

(0.660)
(5)

Pg=2 899+0821 EM-1-183 ENM

(0.387)
(0.169)

R 2=842

where Pg denotes growth rates of GDP per person in civilian employ-

ment,andEM andENM denote growthratesof employmentin manufacturing and non-manufacturing respectively.

It follows from the above also that in a mature economy it would be
idle to look for evidence of a labour constraint in manufacturing either
in terms of a differentialrise in wages in manufacturing or in the relative
incidence of unemployment and unfilled vacancies in the different
sectors. Since the supply of labour to industry does not become inelastic
until wages in the rest of the economy have risen to levels comparable to
those in industry, an effective labour constraint in manufacturingwould
manifest itself in a general increase in wages throughout the economy,
and in low levels of unemployment in all sectors. In a situation of
approachinglabour shortage one would expect the unemployment rate
to be falling, and wages to rise faster in the non-manufacturing sectors
than in manufacturing.1
One would expect, furthermore, that in a "mature" economy constrained by a labour shortage, the average level of unemployment would
be higher in the manufacturing sector than in the rest of the economy,
and not lower. This is because such an economy is almost inevitably
1 This has characterizedthe recent situation in the United States where, pari
passu with a large increasein employment in the manufacturingsector (of 2-8 per
cent. a year in the last five years), wages rose faster in the low-paid sectors (wholesale and retail distribution and agriculture)than in manufacturing.(Cf. Annual
Reportof the Councilof EconomicAdvisers,Washington,D. C., 1968,pp. 109-10.)
It should also be pointed out that in the United States(wherethe level of unemployment has been much greaterthan in the United Kingdom throughoutthe post-war
period) earnings in manufacturingare much higher in relation to the national
average (and particularlyin relation to agriculture and the distributive trades)
than in the United Kingdom.

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1968]

PRODUCTIVITY/GROWTHIN MANUFACTURINGINDUSTRY

389

subject to a "stop-and-go" cycle; variations in the pressure of demand

induced by fiscal and monetary policies affect demand and employment
in industry far more than in the non-industrial sectors.
There is finally the question of the existence of increasing returns to
scale in manufacturingindustries. I emphasized in my lecture that this is
a ".macro-phenomenon" which (in the words of Allyn Young) "cannot
be discerned adequately by observing the effects of variations in the size
of a particular firm or of a particular industry". Studies relating to the
cost and size of individual plants are not therefore necessarily relevant;
though there is a growing body of empirical evidence relating to
individual industries which tends to confirm its importance.Nor do recent studies which fit production functions by means of
linear multiple regressions lead to any confirmation that the parameters
of a Cobb-Douglas function conveniently add up to unity. Indeed in all
recent studies the Cobb-Douglas function was assumed to be a constantly shifting one, of the form AectKaLband not AKaLb,as indicated
by Wolfe; and in many of these studies the result a + b =1 is a tautological one which gives no indication whatever of the presence or absence
of economies of scale.2
Wolfe was mistaken in suggesting that the constant in the regression
equation of output on employment is an "error term". It is a constant
term, which reflects explanatory variables that were excluded, one of
which may be an autonomous time trend. It does not follow, therefore,
that the introduction of further explanatory variables (such as capital
investment) would necessarily reduce the value of the regression coefficient on employment-if the two variables are not inter-correlated,the
introduction of a capital term should reduce the constant term, and not
the regression coefficient on employment. Since owing to the acceleration principle there is always some inter-correlationbetween the rate of
growth of employment and investment activity, one would expect a
multiple regression of output on employment and capital investment to
show lower coefficients on employment than a simple regression: but
there is no reason to expect that the sum of the two coefficients in the
one case should be lower than the single coefficient in the other case. I
have indeed computed multiple regressions of output on employment
and investment, and they show that even when the role of capital is
taken into account, the regression coefficient of output on employment
remains significantly greater than one.3
I See for example, J. S. Bain, Barriers to New Comnpetition;
C. Pratten and
R. M. Dean, The Economies of Large Scale Produictionin British Industry-an
IntroductoryStudy; J. W. Kendrick, ProductivityTrendsin the United States; as
well as the sources quoted in E. F. Denison, WhyGrowthRates Differ,chapteron
Economies of Scale.
2 The existenceof a linear-homogeneousproductionfunction is derivednot from
observationbut from a priori reasoning (i.e. profit maximizationunder conditions
of perfectcompetition) and the parametersare either "restricted"so as to add up
to unity, or else are directly estimated from factor shares which by definition add
up to unity.
3 These multiple regressions were unfortunately not completed in time to be

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390

ECONOMICA

[NOVEMBER

It would be wrong to suppose that the regression between output and

employment showing a coefficient that is significantlygreater than unity
is a reflection of short-term or "cyclical" influences. The figures in my
inter-country studies related to averages of ten-yearly periods, taking
two-year averages for both the base-year and the end-year. This virtually eliminates short-period or cyclical influences. The short-period
relationship between output and employment-showing in some cases
a 5:1 relationship-largely reflects changes in the degree of utilization of
capacity. But the fact that there is short period relationship of 5: 1 does
not exclude a long-period relationship of 1'5: 1. It certainly provides no
support for assuming that the long-period relationship must be smaller
than 1: 1.
Nor is it correct to suppose that more than a small part of the
"Verdoorn Law" can be explained by "embodied" technical progress
coupled with the association of a relatively high level of investment in
fast-growing industries, in the absence of increasing returns. Unless one
assumes that the rate of technical progress on successive vintages is
itself accelerated as a result of a larger volume of investment (as in
Arrow's "learning function", which comes to the same thing as increasing returns) the mere postulate of embodied technical progress does not
entail that the average rate of growth of productivity should be significantly faster in the faster-growing industries.'
Differences in "saving propensities" (as measured by differences in
the investment/output ratio) cannot account for more than a small
proportion of the observed differences in growth rates. Wolfe is correct
in saying that I do not regard "the supply of capital as a serious limitation on economic growth". This is because savings and capital accumulation in a capitalist economy do not represent an independent variable
-a faster rate of growth induces a higher rate of investment; it also
brings about a higher share of savings to finance that investment,
through its effect on the share of profits. It is therefore more correct to
say that a fast rate of capital accumulation is a symptomof a fast rate of
growth than a cause of it.
I shall refrain from comment on the last sections of Professor Wolfe's
paper concerning "policy recommendations", where he charges me with
several sins of both omission and commission. My lecture was concerned
with the question why growth rates differ between different countries.
The Selective Employment Tax, public sector expenditure, immigration,
birth control, etc. were outside its scope and none of these was mentioned.
included in the statisticalnotes appended to my inaugurallecture; they are, however, included in the American version, Strategic Factors in Economic Development, op. cit., pp. 81-3. (In these equations the capital term is measured by the
investment/outputratio in industry, which gives-under the assumption that the
marginal capital/output ratio is greaterthan unity-a lower limit to the "capital
term" of a Cobb-Douglas function. Direct measurementof the rate of growth of
the capital stock would have been impossible statistically and pretty meaningless
theoretically.)
' The reasonsfor this cannot be gone into here; they are set out in a forthcoming
paper by W. A. H. Godley.

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1968]

PRODUCTIVITY/GROWTHIN MANUFACTURINGINDUSTRY

391

Finally, I would commend to Professor Wolfe the following lines

from Pope's Essay oz Criticisnm:
"A perfectJudgewill read each work of Wit
With the same spirit that its authorwrit;
Surveythe WHOLE,nor seek slight faults to find
Wherenaturemoves, and rapturewarmsthe mind;
.... In wit, as nature,what effectsour hearts
Is not th'exactnessof peculiarparts;
'Tis not a lip, or eye, we beautycall,
But the joint force and full result of all."
King's College, Cambridge.

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