Beware Profit-Driven Automation that Shrinks the Economy

[Artūrs Kaņepājs]

Epistemic status: moderate confidence about internal validity, low about external validity. I have a background in Economics and think the key argument that automation does not necessarily grow the economy holds. However, more realistic models would need to consider numerous additional factors.

TL;DR

The profit motive can drive firm owners to automate even if it leads to a decline in total output. Conceptually simple solutions, such as transfers proportional to the new output, can address this problem.

Introduction

A common assumption suggests that automation, despite causing layoffs, increases aggregate output. This idea often stems from counterarguments to the Lump of Labor fallacy, which posit that displaced workers may find new, better jobs. However, this argument breaks down under full automation.

The Profit Motive in Automation

Consider a simplified closed economy where income and output are divided between firm owners and employees. Let $w$ represent the labour share of income, which ranges between 50% and 70% in most economies. Firm owners will be motivated to automate if the following inequality holds:

$$q^{\prime }>q\times (1-w)$$

Here, $q^{\prime }$ and $q$ are the new and old levels of output, respectively. Given the above numbers, there’s a profit-driven motivation to automate even with a 50% to 70% drop in aggregate output. Essentially, firm owners aim to secure a slightly larger share of a significantly smaller economic pie.

Edit: An Example – Automated Taxis

Imagine a single taxi firm where drivers, also employees, earn and spend on the service. When automation becomes viable, firm owners will decide to go ahead if it increases the number and/​or the quality of rides they use, i.e. if the condition $q^{\prime }>q\times (1-w)$ is met. Upon automating, drivers lose their income and, consequently, access to the service.

Policy Solutions: Proportional Transfers

One remedy would involve post-automation transfers to the former employees. Let $t$ represent the proportion of these transfers relative to the whole economy. Then, firm owners will automate if and only if:

$$q^{\prime }\times (1-t)>q\times (1-w)$$

Specifically, setting $t=w$ ensures that automation occurs only when it results in a Pareto improvement, making someone better off without making anyone else worse off.

Conclusion

The key takeaways are:

• The profit motive can drive firm owners to automate even if it leads to a decline in total output.

• Conceptually simple solutions, such as transfers proportional to the new output, can address this problem.

Acknowledgements: Thanks to my friend Krišjānis whose feedback helped me clarify the argument. Also, I used GPT-4 to improve the clarity of the writing and some formatting aspects, and Bing Image Creator/​DALLE-3 for the preview image.

[harfe]

I feel like this article could be improved by adding an example, where we would actually expect a decline in total output.

[Artūrs Kaņepājs]

Thanks, added an example.

[Larks]

Could you attempt to do some microfoundations here? Like explain the situation and decision making for a typical small firm in this example.

[Artūrs Kaņepājs]

Thanks, added an example which I hope clarifies things. In the example, taxi firm owners go ahead with the automation if they become slightly better off as a result, even if it nullifies the output for everyone else.

The example refers to a single firm. To bring this even closer to reality, the situation could be modelled with multiple firms that decide to automate simultaneously, but with fewer available rides, e.g. due to longer average time of the rides. I haven’t done the modelling explicitly but think the basic result would be the same. I.e. firm owners automate even if this leads to lower aggregate output.

[Larks]

Thanks, but I don’t think this example is very informative, because ‘taxi firm whose employees are also the customers’ is such a distant example from reality—in this example the taxi firm has no inputs (oil, cars, computers) and the people don’t buy anything else (food, rent, clothes). Even in communist countries there are often multiple possible employers. The reason I asked for an example for a small firm is because I think this sort of model better capture relevant dynamics in the actual economy (e.g. automation is not costless). Even though it’s not literally true, Perfect Competition is I think a good starting place for this sort of analysis.

[Artūrs Kaņepājs]

Thanks. A general point is that I stripped the model of all nonessential elements (such as non-labor inputs, multiple goods, flexible prices, gradual automation with some firms remaining nonautomated, intl trade) to drive home the basic point that automation does not necessarily lead to an increase in output. That the interests of the firm owners are aligned with the output they get, not that of the total economy. One parallel (non-generous to firm owners) is to a dictator who may wish to increase grip of power at a huge cost to their country.

Now, if workers can find new jobs, possibly even in other industries, this is not a problem. This is the default argument and, at least over timelines that span generations, empirical observation. But this no longer holds when there are no other jobs, i.e. under fool automation. I am now not sure if the “full economy-wide automation” idea was clear in the post, maybe I should clarify it...

It does not seem that Perfect Competition alone would influence the result: the firms that automate would outcompete those that don’t. Also, it does not seem like constant per-unit of output costs (e.g. oil) would change much. Semi-fixed or fixed costs (cars, computers) could have more complex effects, probably dependent on the parametrization. I agree the model can be extended in a number of ways, this could be one.