After years of telling the world the market knows best and not to interfere with its workings it took a matter of weeks for the Western economic establishment to row back on that conviction. This belief in the free market to generate wealth and allocate it among society's participants has been at the center of American culture for many years. At the center and maybe the most defining characteristic of American culture.
In the headlong rush to come up with a large enough number for the government intervention to save the system from collapsing there has been little discussion of what this instant 'about turn' will cause to the American psyche and American culture. What is puzzling is the speed with which the top economists changed their views completely to where government intervention and even nationalisation is essential. One would have to wonder if they ever believed in the free market in the first place and always knew that what existed in the US was not free market capitalism but what Noam Chomsky calls State Capitalism. That however is a question for another day and one that would be hard to answer given the bent for oratory and mendacity the charlatans at the global helm have long displayed. For example developing nations have long found that the free market mantra coming out of Washington was a one way street as they faced massive protection from Western economic blocs.
It is true the world moves at a much faster pace in the 21st century than at any time in history but has any society had to change its grand narrative in such a short period of time? So far the results have been some job losses, some contraction in spending and the disappearance of a great deal of paper and real wealth. But surely some kind of vacuum has been left behind in the whirlwind shift in the foundation to the cultural belief of American society? This void will have to be filled and in this process the history of this turbulent time will be found. Not only will American have to save its economy but once that job is done it will then have to find itself a new self.
Wednesday, November 26, 2008
Thursday, November 20, 2008
Puzzle - why is Wealth Disappearing?
Wealth increases when there is an increase in the output of goods and services that are demanded by consumers. Productivity is linked to wealth in that increases in productivity lead to increases in output for the same level of inputs. However, it must be output that is demanded by consumers - if new houses in the desert are built more quickly than before, due to some better process, but consumers do not demand those houses then the wealth is not created. In fact there is a loss on account of the capital that is consumed in the production of those houses. The good news on the productivity front is that if they are built more efficiently the loss is not as great as it would have been.
New technology very often increases productivity but it also can produce new products that are demanded by consumers. So once again there is an increase in wealth. So at least with the technology bubble there was some new wealth produced from the new products and increase in productivity due to connectivity. Sure it was massively overpriced by the sales people of Walls St but there was something behind it. The problem with the housing bubble, created from the cheap money efforts to prevent asset repricing in technology, is that unfortunately there were no contributions to productivity, no new products and it definitely destroyed more capital than it produced.
The final piece in the puzzle relates to consumer demand. Obviously with less wealth around consumers are demanding less of many things. Those things which once had a value no longer do if they are no longer demanded. On top of this recessionary behaviour cultural shifts away from full on consumerism (consumer fatigue, environmentalism, bling no longer being the thing, etc) should also be considered. Not only must the world face the repricing of assets/wealth that were overstated it must also watch wealth that once was there disappearing into thin air.
New technology very often increases productivity but it also can produce new products that are demanded by consumers. So once again there is an increase in wealth. So at least with the technology bubble there was some new wealth produced from the new products and increase in productivity due to connectivity. Sure it was massively overpriced by the sales people of Walls St but there was something behind it. The problem with the housing bubble, created from the cheap money efforts to prevent asset repricing in technology, is that unfortunately there were no contributions to productivity, no new products and it definitely destroyed more capital than it produced.
The final piece in the puzzle relates to consumer demand. Obviously with less wealth around consumers are demanding less of many things. Those things which once had a value no longer do if they are no longer demanded. On top of this recessionary behaviour cultural shifts away from full on consumerism (consumer fatigue, environmentalism, bling no longer being the thing, etc) should also be considered. Not only must the world face the repricing of assets/wealth that were overstated it must also watch wealth that once was there disappearing into thin air.
Friday, November 14, 2008
The Knowledge Problem in a Complex Society
It is clear that incorrect economic model building and government interventions, which lead to moral hazard, have contributed to this current economic crisis. Amid the confusion, political sound bites and the blame game, the free market has been labeled as the culprit. If only market forces had been allowed to act in the beginning then the inefficient actors in the market place would be long out of business and not hanging around looking for bailouts. Apart from the house of cards in the area of financial assets a house of cards of economic theories has been building up over the years. In the almost 80 years that have passed since the great crash the feeling is that economic theory has advanced so much that a return to such a disaster would be able to be prevented. The claims of this advance in knowledge must surely be in doubt now. Further could the utilization of such incorrect knowledge have led to an even worse outcome? With the Nobel prize in economics being handed out each year for often diametrically opposing schools of thought it is hard to know what economics is telling us right now as governments look to it for guidance.
This knowledge breakdown due to information overload and competiting narratives in a world of complexity brings us nicely to a problem which should be considered for the global economy. Are there problems now, as global societies are becoming ever increasingly more complex, that the free market faces as the optimum means of organising the economy that would not have been an issue in the past? In answering this let us remind ourselves of the main reason why the actions of individual people for guiding economic activity is better than that of government. In our complex societies knowledge is not known to any single mind or group of people therefore it is better to allow people to make the decisions in areas they have the best knowledge in. As Fredrick Hayek put it so well:
"It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality."
However, it would do us well to point out that there are some problems with disaggregated knowledge of individuals with our increasingly complex world.
1) In the networked world there is such a deluge of information that it is a real challenge for people to interpret it correctly. In fact it is possible to created the knowledge you want by simply picking the information you want. Whatever you want to believe it is possible to find some information to back up your view out there on the information highway.
2) There are also vast amounts of information that is hidden by complexity or simply sitting in databases without the ability to view or understand. Many people involved in the financial industry are admitting now that they couldn't even understand the complex models that were pricing derivatives and hence simply did not have the knowledge of what the risks and values were.
3) The free market looks to the knowledge superiority of individuals but huge global firms, often made up of mergers of many other firms, have been emerging. Simply trying to unify the information systems of such firms are projects that often involve years. Beyond the information systems there is all the knowledge in the employees heads which led the Hewlett-Packard's Lew Platt to lament "If only HP knew what HP knows"
4) There are massive cultural differences in a relativistic post modern world. Cultures are changing much faster than before and due to different generational cultural beliefs the communication of what each knows becomes much more difficult. A financial industry worker quoted in the English Independent put this succinctly:
"The belief systems of the three groups – the strategists, the managers and the traders – are entirely different," concludes Glassey. "They don't really understand one another at all. And they didn't know what each other really wanted or expected out of the complex financial architecture they created.
As societies become more complex there are increasing costs associated with the complexity and when the costs start to outweigh the benefits there is a threat of a breakdown. Some of these costs have manifested themselves in the areas such as the environment and energy. However in the information age where optimum knowledge is harder to find there is clearly a breakdown. If the world of economics is looking for the culprit in the current global breakdown perhaps it should pay more attention to the knowledge problem.
This knowledge breakdown due to information overload and competiting narratives in a world of complexity brings us nicely to a problem which should be considered for the global economy. Are there problems now, as global societies are becoming ever increasingly more complex, that the free market faces as the optimum means of organising the economy that would not have been an issue in the past? In answering this let us remind ourselves of the main reason why the actions of individual people for guiding economic activity is better than that of government. In our complex societies knowledge is not known to any single mind or group of people therefore it is better to allow people to make the decisions in areas they have the best knowledge in. As Fredrick Hayek put it so well:
"It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality."
However, it would do us well to point out that there are some problems with disaggregated knowledge of individuals with our increasingly complex world.
1) In the networked world there is such a deluge of information that it is a real challenge for people to interpret it correctly. In fact it is possible to created the knowledge you want by simply picking the information you want. Whatever you want to believe it is possible to find some information to back up your view out there on the information highway.
2) There are also vast amounts of information that is hidden by complexity or simply sitting in databases without the ability to view or understand. Many people involved in the financial industry are admitting now that they couldn't even understand the complex models that were pricing derivatives and hence simply did not have the knowledge of what the risks and values were.
3) The free market looks to the knowledge superiority of individuals but huge global firms, often made up of mergers of many other firms, have been emerging. Simply trying to unify the information systems of such firms are projects that often involve years. Beyond the information systems there is all the knowledge in the employees heads which led the Hewlett-Packard's Lew Platt to lament "If only HP knew what HP knows"
4) There are massive cultural differences in a relativistic post modern world. Cultures are changing much faster than before and due to different generational cultural beliefs the communication of what each knows becomes much more difficult. A financial industry worker quoted in the English Independent put this succinctly:
"The belief systems of the three groups – the strategists, the managers and the traders – are entirely different," concludes Glassey. "They don't really understand one another at all. And they didn't know what each other really wanted or expected out of the complex financial architecture they created.
As societies become more complex there are increasing costs associated with the complexity and when the costs start to outweigh the benefits there is a threat of a breakdown. Some of these costs have manifested themselves in the areas such as the environment and energy. However in the information age where optimum knowledge is harder to find there is clearly a breakdown. If the world of economics is looking for the culprit in the current global breakdown perhaps it should pay more attention to the knowledge problem.
Tuesday, November 11, 2008
The Consumption Fallacy – Good Money After Bad
The logic behind the bailouts and government stimulus to consumer spending is that such measures will kick start the economy and prevent a deep recession or a recession even occurring at all. This is accepted in many quarters as a sound economic policy. However, when one looks at it closely it doesn't really stand up to scrutiny. If high levels of consumer spending create economic growth then why does the economy fall into recession in the first place? There is no argument that up until 2005/6 the consumers of the Western world were in overdrive not requiring any government encouragement for their activities. The answer that is put forward is that suddenly the consumer loses confidence and this negative psychology, despite what the government's claims are 'sound fundamentals', is what drives the economy into recession.
This leads us to the obvious question why if the fundamentals are sound would the consumer suddenly become negative? In addition to sound fundamentals the government takes every step it can to prevent negative economic news coming into existence. Inflation definitions are changed and various statistical techniques are used to keep the GDP figures above 0. It doesn't seem to matter how many jobs the US economy has lost in the last 18 months as the GDP has mainly been in positive territory. The consumer becomes negative because despite all the spending, and positive economic news, negative economic conditions start to appear. This leads us to the further question why if consumers spending at full tilt does not prevent the economy from falling into recession will stimulus to consumer spending cure the recession? We already know that high levels of consumer spending do not prevent economic downturns.
Is there something all of this beyond market psychology and multiplier effects? Clearly the answer is yes. There is a simple logical economic reality to it all. If over time more economic goods are consumed than are produced, or saved correctly (in areas that will produce goods that will be demanded by consumers at some point in the future) as investments to produce future goods, then wealth decreases. More government attempts to stimulate consumption will actually destroy wealth in the medium term making the current situation even worse and it longer for the business cycle to come back around to where savings and consumption are in the right proportion to produce wealth.
This leads us to the obvious question why if the fundamentals are sound would the consumer suddenly become negative? In addition to sound fundamentals the government takes every step it can to prevent negative economic news coming into existence. Inflation definitions are changed and various statistical techniques are used to keep the GDP figures above 0. It doesn't seem to matter how many jobs the US economy has lost in the last 18 months as the GDP has mainly been in positive territory. The consumer becomes negative because despite all the spending, and positive economic news, negative economic conditions start to appear. This leads us to the further question why if consumers spending at full tilt does not prevent the economy from falling into recession will stimulus to consumer spending cure the recession? We already know that high levels of consumer spending do not prevent economic downturns.
Is there something all of this beyond market psychology and multiplier effects? Clearly the answer is yes. There is a simple logical economic reality to it all. If over time more economic goods are consumed than are produced, or saved correctly (in areas that will produce goods that will be demanded by consumers at some point in the future) as investments to produce future goods, then wealth decreases. More government attempts to stimulate consumption will actually destroy wealth in the medium term making the current situation even worse and it longer for the business cycle to come back around to where savings and consumption are in the right proportion to produce wealth.
Saturday, November 8, 2008
Trade Wars Ahead
The free market and the theory of comparative advantage are great when your country is producing high value products that provide high value jobs. However, things become a little different when other countries start to out compete you in these industries. After years of preaching the gospel of free markets and the evils of protectionism in the blink of an eye the US has turned on a dime. It is hard to keep up with the slew of protectionist measures that are coming out of Washington and the queue at the door for capital injections is getting longer on a daily basis with the US auto makers currently at the head of the line. Governments tend to avoid tariffs for their inflammatory nature but subsides, capital injections, or whatever seemingly passive techniques they can dream up, are instruments of protection pure and simple.
It is ironic watching the Chyrsler's hedge fund owners Cerberus demanding a government bailout and in the US these auto bailouts may be popular but none of this takes away from the fact that such bailouts will only make matters worse. Chyrsler are in difficulty because they are making cars that consumers do not want. Toyota and Honda do not need to be bailed out in these difficult times. So more US wealth will be destroyed by promoting the production of cars that consumers do not want. Money will be redirected from taxpayers toward these companies and not used in a manner that could produce wealth in the future. More worryingly these protectionist measures will soon be seen for what they are. They are not a way of saving the world economy but a measure to save nationalist industries and this will create a high risk of trade wars. When these wars break out the final engine of trade that is keeping the world economy afloat will be shut down.
It is ironic watching the Chyrsler's hedge fund owners Cerberus demanding a government bailout and in the US these auto bailouts may be popular but none of this takes away from the fact that such bailouts will only make matters worse. Chyrsler are in difficulty because they are making cars that consumers do not want. Toyota and Honda do not need to be bailed out in these difficult times. So more US wealth will be destroyed by promoting the production of cars that consumers do not want. Money will be redirected from taxpayers toward these companies and not used in a manner that could produce wealth in the future. More worryingly these protectionist measures will soon be seen for what they are. They are not a way of saving the world economy but a measure to save nationalist industries and this will create a high risk of trade wars. When these wars break out the final engine of trade that is keeping the world economy afloat will be shut down.
Wednesday, November 5, 2008
The Economics of Obama
Barack Obama has been voted in to change the lives of Americans for the better. In one way he already has for it can now be said that in America a person will be not be ultimately barred from the top because of their color and will be judged on their merit. However, a large part of changing the lives of Americans for the better comes down to the economy and the challenge of making that better. It is clear that people want the economy to grow but as the recent backlash against Wall St and groundswell toward the environmental movement shows the majority of people want this to happen in a more equal and sustainable way. There is no point in the economy growing by 5% if most of the increases go to Wall St bankers, who it turns out haven't even been creating wealth with their financial alchemy, and if people feel there won't be a much of a world left for their grandchildren.
All the same there is not much new to all of this for people have always been swept into power with the promise of something better and the choice of tools to use is still the same. What mix of market forces and government regulation should be used to improve people's lives? The pre-election collapse of the free market model was a key factor in bring Obama into power and as someone who is viewed as a left leaning democrat does that mean Obama is going to lean heavily toward the government and avoid the market to create the wealth to improve people's lives?
However, we must examine if Obama really believes that the current US economic system is a free competitive one or more like one which Noam Chomsky calls 'State Capitalism'. Looking at what Obama has actually says gives us a clue as to what he really believes.
It is clear he has noticed the large scale involvement of the state in the market which has actually led to an unfair and uncompetitive market. For example, in farming he points out that big government subsidies have helped large businesses in the market place at the expense of the smaller farmers:
"And that is that our Congress subsidizes these big megafarms and hurts family farmers oftentimes in the process. And we've got to, I think, cap those subsidies so that we don't have continued concentration of agriculture in the hands of a few large agribusiness interests."
He does not appear to want to turn his back on competition and trade to solve the problems of employment:
"But, on the trade issue generally, we're not going to suddenly cordon off America from the world. Globalization is here, and I don't think Americans are afraid to compete. And we have the goods and the services and the skills and the innovation to compete anywhere in the world."
Notwithstanding any left-wing slogans that can be stuck on to a Chicago Democrat, it appears that in reality Obama has market based leanings and is looking to the market for incentives to solve problems. For example, using market incentives to solve teacher remuneration and quality of teaching issues:
"I actually think that we can implement a performance-based system that teachers buy in to. Teachers, across the board, have to be paid more. My sister's a teacher, and I know how hard they work and what they go through. But we've got to give them a pathway so that they can make more money, as they are developing more experience, as they are putting more into the classroom."
He does not want a Statist solution of imposing health care on everyone but wants to reduce the cost to incentivise people to make the rational choice, as the benefits are greater than the costs, to buy in to health care.
I disagree with that because as I go around town hall meetings, I don't meet people who are trying to avoid getting healthcare; the problem is they can't afford it. The costs are too high. And so, as a consequence, we focus on reducing costs.
The state should only intervene where people don't have a choice:
"SEN. CLINTON: Well, but I want to go back to health care and make another point. You have a mandate in your health care plan.
SEN. OBAMA: For children.
SEN. CLINTON: You mandate -- you mandate parents to have health care for children.
SEN. OBAMA: That's exactly right.
SEN. CLINTON: And obviously you did that because you want all children covered.
SEN. OBAMA: Because they don't have a choice."
So when we look at his words it is clear that Obama is all about individual choice, and making the market more competitive to bring down costs so people can rationally choose to opt in for services. Making the economic system more equitable and competitive also encourages the buy in and this involves tackling the monopoly of big business which works to rig the market in its favour:
So what I've said -- and I know some others on this stage have said -- is that among the options that are available, the best one is to lift the cap on the payroll tax, potentially exempting folks in the middle -- middle-class folks -- but making sure that the wealthy are paying more of their fair share, a little bit more.
Now, in the meantime, we've got a 10,000-page tax code that is rife with corporate loopholes. There's a building in the Cayman Islands that supposedly houses 12,000 U.S. corporations, which means it's either the largest building in the world or the biggest tax rip- off in the world, and I think we know which one it is. So there has to be a restoration of balance in our tax code to help that single mom, to help a two-parent working family that are struggling to make ends meet.
If government can become a referee that creates the conditions where the creation of goods and services can take place in a fair and competitive market place he has a chance of delivering on his promises. Obama is clearly smart enough to see that a solution where the State attempts to create the wealth (for example, Cuba, Soviet Russia), or the market is prevented from working by large private monopolies and lobby groups, will only lead to the destruction of wealth and a poorer society.
All the same there is not much new to all of this for people have always been swept into power with the promise of something better and the choice of tools to use is still the same. What mix of market forces and government regulation should be used to improve people's lives? The pre-election collapse of the free market model was a key factor in bring Obama into power and as someone who is viewed as a left leaning democrat does that mean Obama is going to lean heavily toward the government and avoid the market to create the wealth to improve people's lives?
However, we must examine if Obama really believes that the current US economic system is a free competitive one or more like one which Noam Chomsky calls 'State Capitalism'. Looking at what Obama has actually says gives us a clue as to what he really believes.
It is clear he has noticed the large scale involvement of the state in the market which has actually led to an unfair and uncompetitive market. For example, in farming he points out that big government subsidies have helped large businesses in the market place at the expense of the smaller farmers:
"And that is that our Congress subsidizes these big megafarms and hurts family farmers oftentimes in the process. And we've got to, I think, cap those subsidies so that we don't have continued concentration of agriculture in the hands of a few large agribusiness interests."
He does not appear to want to turn his back on competition and trade to solve the problems of employment:
"But, on the trade issue generally, we're not going to suddenly cordon off America from the world. Globalization is here, and I don't think Americans are afraid to compete. And we have the goods and the services and the skills and the innovation to compete anywhere in the world."
Notwithstanding any left-wing slogans that can be stuck on to a Chicago Democrat, it appears that in reality Obama has market based leanings and is looking to the market for incentives to solve problems. For example, using market incentives to solve teacher remuneration and quality of teaching issues:
"I actually think that we can implement a performance-based system that teachers buy in to. Teachers, across the board, have to be paid more. My sister's a teacher, and I know how hard they work and what they go through. But we've got to give them a pathway so that they can make more money, as they are developing more experience, as they are putting more into the classroom."
He does not want a Statist solution of imposing health care on everyone but wants to reduce the cost to incentivise people to make the rational choice, as the benefits are greater than the costs, to buy in to health care.
I disagree with that because as I go around town hall meetings, I don't meet people who are trying to avoid getting healthcare; the problem is they can't afford it. The costs are too high. And so, as a consequence, we focus on reducing costs.
The state should only intervene where people don't have a choice:
"SEN. CLINTON: Well, but I want to go back to health care and make another point. You have a mandate in your health care plan.
SEN. OBAMA: For children.
SEN. CLINTON: You mandate -- you mandate parents to have health care for children.
SEN. OBAMA: That's exactly right.
SEN. CLINTON: And obviously you did that because you want all children covered.
SEN. OBAMA: Because they don't have a choice."
So when we look at his words it is clear that Obama is all about individual choice, and making the market more competitive to bring down costs so people can rationally choose to opt in for services. Making the economic system more equitable and competitive also encourages the buy in and this involves tackling the monopoly of big business which works to rig the market in its favour:
So what I've said -- and I know some others on this stage have said -- is that among the options that are available, the best one is to lift the cap on the payroll tax, potentially exempting folks in the middle -- middle-class folks -- but making sure that the wealthy are paying more of their fair share, a little bit more.
Now, in the meantime, we've got a 10,000-page tax code that is rife with corporate loopholes. There's a building in the Cayman Islands that supposedly houses 12,000 U.S. corporations, which means it's either the largest building in the world or the biggest tax rip- off in the world, and I think we know which one it is. So there has to be a restoration of balance in our tax code to help that single mom, to help a two-parent working family that are struggling to make ends meet.
If government can become a referee that creates the conditions where the creation of goods and services can take place in a fair and competitive market place he has a chance of delivering on his promises. Obama is clearly smart enough to see that a solution where the State attempts to create the wealth (for example, Cuba, Soviet Russia), or the market is prevented from working by large private monopolies and lobby groups, will only lead to the destruction of wealth and a poorer society.
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