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The Promise and Challenges of Incremental Rates

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By Susan K. Schroeder

Over my career, thus far, I have argued for the synthesis of Hyman Minsky’s Financial Instability Hypothesis (the ‘FIH’) with a modern variant of classical political economy. With this foundation, I believe, it possible to create more robust methods to detect cyclical patterns and country risk in a more systematic way.

The linkage between this particular theory of value and the enhancement of the FIH, I have argued, is facilitated through the use of incremental rates. One in particular, the incremental rate of return on new investment, captures  the relentless quest for profit by firms (nonfinancial and financial) and how they benefit from the maltreatment of workers and the environment in order to obtain it. The rate is defined as the change in profit relative to a unit of new investment (Shaikh 2016).   Cast at the level of industries and the economy, it reflects changes in firms’ conditions of production as they attempt to increase profit (reduce unit costs) through enhanced mechanization, at the expense of workers and working conditions, and pressure environmental protection. It acts as the benchmark against which the efficiency of a firm is compared with its industry’s and with the economy.   The strength of a firm’s efficiency, in terms of unit cost of output, is a signal as to whether it needs to make adjustments to its productive process (to lower unit cost) or perhaps change industries. As such capital flows between firms within and between industries change and generate dynamics associated with instability . When firms change their individual conditions of production, they modify the range of conditions of the industries in which they operate. Thus, the benchmark against which each firm compares itself is always changing. Moreover, the industrial benchmarks are influenced by the strength of conditions of supply and demand and the entry and exist of firms. Underlying these changes within and between industries is a tendency for a falling rate of profit for the overall economy. Consequently, there is no natural tendency for a market economy to seek a state or path of stable growth, where bouts of instability could possibly occur. Rather, balance is a particular moment, a fluke, in the context of an inherently unstable economy. There are general tendencies where bouts of instability are more likely, than not, to occur. The frequency of bouts of instability depends on the resiliency of an economy and its financial system.   (Interested readers are referred to chapter 3 of Schroeder (2015) for a more detailed explanation.)

I initially worked with this concept as a research assistant to Anwar Shaikh (New School for Social Research, New York) in his examination of the relationship between the corporate rate of return and the incremental rate. I have been applying various time series techniques to this rate in combination with others, as identified through a Minskian cash-flow framework, and have also applied the approach to countries such as Korea, Thailand, the United States, New Zealand and Australia. As I ready additional cases for a book manuscript on the relationship between country risk, financial fragility and business cycles, I am encouraged by the usefulness of this concept. Yet, there are both challenges and opportunities ahead.

What my synthesis suggests is that the strength of social safety nets, income distributions and industrial configurations matter – and why they matter. They matter for enhancing the resilience to crises of market economies, which are inherently unstable, and promoting the development of contexts in which people and the environment can thrive. Using the United States as my focus in recent work (Schroeder 2015, 2016), I found that as income distribution widened, reflecting a weakening social safety net, and the more pronounced the activities of the financial sector (includes banks) became, the American economy became increasingly fragile and dependent on financial, and largely unproductive, activities. The financial sector, essentially, has it foot on the throat of the American economy and generations of Americans. This is what my use of incremental rates , as knit between classical political economy and Minsky’s FIH, is starting to reveal – what many of us have known all along – but from a different angle. The FIH gives a strong role for the interest rate in contributing to bouts of instability, but up to now it has lacked an explanation of the profit rate.   The incremental rate facilitates the integration of the changes in the conditions of production with the debt dynamics of the FIH. In other words, the synthesis of the FIH with a modern variant of classical political economy enables a more complete understanding of Minskian debt dynamics.

However, each society is different in terms of its culture, political and legal apparatus, institutions and environment. What may be suited to the United States is not likely to be well-suited for other countries. The reversal of widening income distributions, the enhancement of social safety nets (perhaps implementation of a living wage), and revision of patterns of industrial configurations will need to be different and well-considered for how they support the societies. However, over the past 30-40 years, mainstream economics has lent itself to justifying weakening safety nets (through austerity programs), promoting implicit industrial policies (in which markets guide the development of industries according to profitability), increasing worker insecurity (by removing worker protections), and savaging the environment by weakening protections of it.

At the heart of mainstream economics is the vision that a capitalist market economy is inherently stable, and that imperfections and asymmetries are preventing the achievement of a state of balance or balanced growth path. My efforts are based upon a vision that a market economy is inherently unstable. There are no stable or balanced paths, only periods in which relative stability might be attained. Thus, the promotion of resiliency to financial crisis and economic stability requires a different style of managing the economy and a different role for government. Rather than unleashing the power of markets, a government needs to protect society from the externalities free markets unleash. This is what the generations who experienced the Great Depression recognised. Dare we repeat the history that we are forgetting?

Shifting to better economic and financial stability and social outcomes may be easier to achieve than one realizes. Rather than trying to achieve a stylized state of balance – unattainable (being based upon an unrealistic economic rationale) – it is about creating new approaches to policy and community support mechanisms to simply to improve, and continue to improve, our current situations.   If the quest for unbridled profit is interfering with the social provisioning of goods and services adequate to support families, the working poor and elderly, for instance, then it’s time to look for ways to do that without relying so heavily on the market mechanism. Sharing and time-sharing efforts hold promise for people to connect and swap items, surplus produce and time to attain what they need. These are challenges.

I realize that I do not work in a vacuum. There are people who are interested in the use of incremental rates, and Shaikh’s incremental rate of return on investment, in particular, and who have used them for a variety of purposes in their research. I would love to learn about others’ experiences. And, so I write this note to ask those who are interested to engage with me on your usage and findings regarding the incremental rates, with an eye towards organizing a conference (or two) and collaborative research projects, to please contact me. I look forward to hearing from you soon!

Susan K. Schroeder, Department of Political Economy, University of Sydney


Schroeder, S. K. (2015) Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets. New York: Palgrave Macmillan.

Schroeder, S. K. (2016) “Credit as a Means of Social Provisioning.” Journal of Economic Issues 50(2): 549-556.

Shaikh, A. (2016). Capitalism: Competition, Conflict, Crises. Oxford and New York: Oxford University Press.

From: pp.4-5 of World Economics Association Newsletter 6(3), June 2016

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2 responses

  • Murray Duffin says:

    “One in particular, the incremental rate of return on new investment, captures the relentless quest for profit by firms (nonfinancial and financial) and how they benefit from the maltreatment of workers and the environment in order to obtain it.” Here you put your finger on one of the sources of instability. In this context management usually deals only with one measurement of performance, and only with short term maximization rather than long term optimization. The problem derives from an incorrect system of measurement. (What gets measured is what gets done). Improving profit can be sustained more stably over the long run through the practise of TQM (The Total Quality of Management) without maltreatment of workers and the environment, but that requires focus on more than one goal. I suspect that the study of incremental rates, at least in the corporate world, cannot be separated from the study of management.

  • Frank Stilwell says:

    I think that the connections sketched out in this short article, particularly those linking the theoretical propositions to observable social trends, have a strong ring of plausibility. It has the hallmarks of an excellent political economic research program.

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