The Cycle of Rents: Business Cycles as a Result of Social Predator-Prey Dynamics
58 Pages Posted: 2 Nov 2006
Date Written: October 1, 2006
The numerous objections that have been raised for the last quarter of a century against the Real Business Cycle (RBC) models which dominate today's mainstream business cycle theory suggest there is room to explore alternative hypotheses. This paper puts forward an alternative model, based on a strictly neoclassical set of assumptions, which results in a predator-prey process (analogue to the classical Lotka-Volterra ecosystem model) where the administrators (agents) of an economic unit try to maximise their agency rents at the expense of investors (principals). The key results are:
1. Agency rents are higher the more complex (i.e. integrated) the productive process is.
2. More complex/integrated processes also imply more steeply diminishing returns.
3. Under input flow uncertainty, the Total Factor Productivity (TFP) growth rate is slower the higher the agency rents (i.e. the more steeply diminishing the returns).
4. As investors liquidate those firms whose market value is lower than their liquidation value, and liquidation means the administrators can no longer extract their rents, the interaction between administrators and investors follows a Lotka-Volterra cycle path.
5. Thus, when times are good and the ratio of market to liquidation value (Tobin's q) is high, rents grow faster. This has a negative effect on the TFP growth rate, which depresses output growth and thus also Tobin's q. This triggers liquidations, which in turn bring rents down until TFP can resume its growth path.
We could thus say that the system accumulates parasitical (i.e. rent-generating) activities in good times until their negative impact on TFP growth rate triggers a recession to "purge them off" before the system can resume growth.
For completeness, this paper also models the impact of the cycle on unemployment (assuming applicability of queuing theory) and on the relative inflation of investment goods vs. output deflator (assuming nominal prices are determined in an efficient market).
Despite its being formally related to Goodwin (1967), this model is based on assumptions falling within the framework of neoclassical economics, including revenue maximisation, rational expectations, Pareto-efficiency and, for the determination of nominal market prices, the efficient markets hypothesis.
Although a thorough empirical test of this model would go beyond this paper's scope, this paper suggests, on the basis of an analysis of the features of this model against well-known stylised facts, that it can portray the observed nature of business cycle phenomena significantly better than the standard RBC.
Keywords: business cycles, trade cycles, predator-prey, agency costs, agency rents, TFP, Total Factor Productivity, RBC
JEL Classification: E32
Suggested Citation: Suggested Citation