What If the Economic Model Is Wrong? 22 comments
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There's been something unsettling to me about Paul Krugman's Great Depression II op-ed piece and I've struggled for a week to figure out what it is. And then today, I came across Umair Haque's piece from last month called Do Economists Matter?
I don't want to disparage Paul Krugman. He's way smarter than I am, he has degrees from Yale and MIT, he's taught at MIT, Stanford, Yale, and now Princeton. He received the Nobel Prize last year in Economics. He's one of the most influential economists, thinkers, and writers in the world.
And yet, Krugman's Depression II piece is essentially a debate and discussion of Keynes vs Friedman, tax cuts versus infrastructure investment. It's a 20th century economics model being applied to a 21st century crisis. And I think there's a really good chance that these models the economists are using are outdated and focused on the wrong issues.
Haque, on the other hand, sees this economic crisis differently. He says:
We can't fix today's problems unless we change yesterday's rules. But economists -- and the models they rely on -- are bounded by yesterday's rules.
I wrote a long piece over the holidays called Bits Of Disruption where I argued that technology has fundamentally changed the economic model of most, if not all, industries and we are witnessing the destruction that goes along with that disruption.
That's one big vector of change, but it's not the only one. Globalization is another huge impact. The most influential book (on me) I read last year was Fareed Zakaria's The Post American World. Surely the economic models our leaders are using incorporate global money flows and other important global factors. But we've never been in a world where you can hire someone anywhere in the world in a matter of days, where you can transact instantly with companies all over the world, and where global factors weigh so heavily on economic issues. I just don't think our models fully incorporate the global world we live in today.
But neither of these vectors are what Umair is obsessively focused on. He sounds more like Marx than any current economist to be honest. Umair's interested in DNA, not what makes each of us unique, but what makes companies, institutions, and even governments unique. And he points out that the old models don't work anymore.
Starbucks, (SBUX) for example, pursued a textbook approach to strategy; growing from a strong core defended by a powerful brand, value chain control, and scale, into adjacent markets, like food, music, and events. All of which led it directly and deeply into strategy decay – by robbing it of purpose, vision, and empathy.
Microsoft, (MSFT) perhaps the ultimate hardball player, focused on ownership of a standard at all costs – and is now struggling to compete in an industry whose fabric has been riven by open standards and open code: its own domination games have returned, like the ghost of strategy past, to haunt it.
The old rules certainly don't work for many (most?) businesses anymore and they probably don't work for the economists either. So Obama will spend upwards of a trillion dollars of stimulus in a combination of tax cuts, building roads, bridges, and hopefully public transportation. And it can't hurt and maybe it will help.
But what matters more is how we change our culture, our society, our government, our economy and the companies that help make it up. A good place to start are Tim O'Reilly's three rules:
1) Work on something that matters more than money
2) Create more value than you capture (that's the kind of DNA that's winning the day now)
3) Take the long view
I had dinner last night with some friends, all of whom were big supporters of Obama and his vision of change. All of us were at least a little (and in some cases a lot) concerned that in the transition from candidate to President, Obama was getting sucked into conventional thinking. Spending a trillion dollars may work, but helping change the DNA of America and the world would help a lot more. And he doesn't need economists to tell him how to do that.
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This article has 22 comments:
Spending huge sums on infrastructure makes sense if the interconnected systems they feed (urban cores and their green corridors) are sustainable for the long term. This means economics must be informed by urban planners, demographers, and the like.
At time s like this I wish I had a better grasp of Buckminster Fuller's ideas. :-)
Yes extremist-capitalist neo-CON tinkle down economic theories are thoroughly discredited and hopefully will soon be as dead as their biggest cheerleader the Gipper himself.
Were it not that the following were so ingrained in the American psyche it may be possible to move forward to a place where Tim O'Reilly's three rules are embraced.
1) the Horatio Alger lie.
2) the mistaken idea that capitalism and democracy are one and the same.
3) American exceptionalism.
Paradigm shifts of the kind you rightly advocate rarely come without tremendous suffering.
How might you envision such a shift transpire?
Thank you very much!
There is a little bit of game theory going on. If all employers in a particular industry agreed to hire local workers, the workers would have money to spend. Competitors would have to compete paying higher wages, but all would be on the same footing and labor costs would be reflected in prices paid by consumers -- so the increased costs would be defrayed to some extent. But without any agreement, everyone has incentive to move jobs overseas and allow someone else to worry about how workerse will subsist.
BTW, culture is changing all the time. It doesn't happen in spurts. What does happen in spurts is the booms and busts. And they happen when the critical mass of changes in culture take their effect.
Good economists and businessmen long ago identified high levels of debt, low investment in our own infrastructure and human capital, low savings rate and arcane financial derivatives as a threat to prosperity.
They turned out to be exactly that. "The models" indicated that our policies would end badly, and they have.
Neither the Starbucks nor the Microsoft case are convincing. Microsoft has been fantastically successful, but the whole point of "the model" is that if a firm stops innovating, its _supposed_ to lose market share. That's how Microsoft ate IBM's lunch after all. Microsoft's been on top in the technology world for two decades. That's a good run, and "the model" all suggests that we'll all be better off if their position erodes. As Microsoft fades, Google and Apple have innovated dramatically . . . that's what "the models" say we _want_ to see happen.
Similarly, Starbucks grew extremely rapidly, saturated the market, and now will retrench, and adjust its business model to a low-growth environment. There's nothing in "the model" that suggests that a company with nearly 20,000 stores can grow quickly.
Unfortunately the answers above are not so right...
the problem is that people (governments, inverstors, etc) are using the wrong economic model. Both Keynes and monetarists are not correct with regard to how they describe economy.
The school that is most close to the trith is the Austrian School (it is called so because it's founding fathers come from Austria; i would rather call it the "capitalist school", since a central piece of it is the theory of the structure of capital).
Anyway - on this site there is a very good, simple and illustrative powerpoint. Take 15 minutes to look at it and you will gain a basic understanding what this school is talking about:
www.auburn.edu/~garriro/ppsus.htm
Also check out
mises.org
for a wealth of literature, critique, commentary on current events, etc.
So - the answer to the question above is - yes we have been using a wrong model; but the right model is not some new, undiscovered yet idea of the type we have been served over and over again by management gurus. The correct model was created 100 years ago. It is just that what it prescribed would call for dismantling of our ill-conceived banking system and in this way - for a serious limitation of government power.
The fact we want to spend all the time isn't Keynsian, it is stupid and selfish. The fact we don't want to prevent corruption and horribly misallocations of assets isn't economic policy it's corruption. The fact that we want to give all Congressional monetary policy to unelected officials is plainly idiotic. The fact we disbanded the only law we designed after the great depression that we knew would secure our financial well being "Glass Stegal" from gambling imprudent bankers is moronic.
You really can't blame the economists alone for this mess. Politicians are always taking words out of a text and bending them to their own cracked interpretations. The fact the Fed and Treasury do the same should have sounded the alarm years ago.
"We can never tell a bubble occurred until afterwards." Alan Greenspan. I can guarantee there will be bubbles after more than 1 year of 2% or lower fed funds rates, and I'm not an economist. Where do these guys come from and why do we hail them as genius'. We need our collective head examined.
Prediction: I can guarantee that there is a lot of waste in the government bailouts and stimulus, and I haven't even got a report about how it was allocated (no one did). That's a big signal in itself that something is drastically wrong.
The extra spending by the government in times of crisis is not the most efficient approach to building value as it is not driven by market forces.
The best approach is lowering income taxes (personal and business). Once the taxes are lowered, the market will automatically re-adjust to the new realities and efficiencies will become apparent.
Busts have happened due to consumer spending going down, which happens when people do not feel secure.
The new administration will probably reduce insecurity among people by creating more government funded jobs, but a boom of 90s or 2004-2006 would probably not be witnessed unless new unique technologies appear from america.
Globalization has existed for a very long time, Read "America's Great Depression" and "The Ascent of Money". You'll be shocked at what has existed and how advanced they were. The Ascent of Money has an excellent chapter on the first major stock market bubble (in the early 1700s) that stemmed from the louisiana territories (in the Americas) and bankrupted France. The Austrian school is pretty sound in its theories.
"Change" can be positive or negative. Positive change is movement toward more human freedom and less government coercion, which means more wealth.
The trend today is toward negative change.
Erecting a second Brooklyn bridge, while it will give jobs for the short run, will do nothing to the financial infrastructure of NY. It will not improve NYC possibilities to compete with other financial centers.
I admit, am a strong supporter of OB, but I am a but afraid that by default moving investments in 1900-2000 era infrastructure is not going to help us compete.
We do need a better educational system - as for now it tends to favor 'old wealth' above keeping the best students as long as possible in the system.
We need a more flexible educational system, the thought that we study till 25 and are done - is so 1900's.
We will need to abandon traditional classroom and traditional one-to-many teaching.
We will need to sit back and blow some smoke to the ceiling and consider in which areas the USA should be leading in 50yrs time.
for me those area should include; energy generation and distribution, medical prevention, robotics, democracy and forward thinking regulations, management style in a global collaborative world. (i am sure there is more).
Selecting these topic is the essential - because the 1Trillion investments will need to support the development of the USA2050.
Be aware not to create a better USA1950 - because then Disney can sell tickets to a very large Open Air Museum.
The intervention by governments through out the world will only lengthen this recession as seen all ready. The average lengths of the recessions in the past have been 12-24 months. This would have stayed through here if the government stayed out; the free market has to decide who lives and dies.
We can’t have it both ways asking for free markets worldwide and then looking for protectionism when things go south. Common sense must prevail at all times as I look at the world stage I see panic all over the place. We as a country have thrown 8.6 trillion dollars at a problem no one knows how to fix except the free markets.
I understand this is a little frustrating to some, as they believe government has the answer to all ails in this country.
If the government stays involved the problem will not fix itself we will have this botched up economy and the world will be going forward like a wounded animal.
Just a thought by a layperson.
They do not explain why standards of living in some capitalistic democratic societies such as Guatemala or the Congo are similar to or lower than standards of living in communist or authoritarian regimes such as Cuba or China. They do not explain how Mexico is so much poorer than the US, even though both are capitalistic democracies (and Mexico even has lower taxes!). In a world of nearly free trade and instant communications, productivity gains don't explain it all, and without an understanding of why economies fail, we could easily stumble into whatever mistakes these countries made.
Key differences between rich or rising economies and failing economies are:
1) Education investment: A generation of illiterate workers cannot produce wealth. The rise of China and India began in the classroom, as did the rise of the US over 100 years ago. Firms have a hard time adding value when they have an uneducated workforce. Nations that don't send their children to school are destined to be poor.
2) Infrastructure: Firms cannot make profits without a way to transport goods, workers, and information. They also cannot profit if they have to build their own interstates, railroads, ports, power plants, water purification systems, etc. Firms need governments to build these things for them, or at least facilitate their construction through easements and emminent domain, distributing the costs through taxation.
3) Stability: Firms will not make long term investments in an environment where periodic coups, revolutions, civil wars, and currency devaluations occur. To an extent, the people have to be committed to their form of government and that government has to be stable. As China demonstrates, stability may be more of a bonus to business than democracy (although it remains to be seen if "capitalistic communism" is sustainable).
4) Rule of Law: Firms cannot operate profitably in an environment where bribes, extortion, blackmail, kidnappings, theft, fraud, and extrajudicial property seizure occur. They also cannot profit in an environment where the government does not enforce contracts, protect property rights, and have a legal remedy for disputes. If you disagree, try setting up a business in Somalia or Hati. Anarchy is an economic problem.
The experience of the last 100 years shows that economic success or decline is based largely on the competence of the government and the society's investment in education and infrastructure. A 21st century economic theory needs to reflect this evidence.
The basics have not changed since Adam Smith summarized them in the late 1700's, and when you look at his references, you discover that his concepts have much earlier roots. Details have changed, but basic fundamentals have not.
Every so often, the irresistible allure of creating wealth out of thin air takes over and a bubble is formed. Whether it is tulips or South Sea companies, or railways or the internet or housing, it's all the same, an attempt to circumvent the most basic rule of creating wealth through hard work.
So the "model" is not broken. Policy making just broke one more time, by trying to circumvent the basic and obvious "model" just one more time.
With that little bit out of the way, it's safe to say you do not need a model to grasp that an economy built upon a mountain of debt and attending asset bubbles is certain to give way.
No it certainly won't. Repeal of Sarbanes-Oxley would, though.
We don't need a new model, and we don't need to change our DNA. PrudentInvestor has it right, the basic model is always the same. In the absense of government interference, the basic model of success will dominate. People will naturally work hard, save, and make sure their children are educated. They will build infrastructure because it is profitable to do so.
Turning the economy over to govrnment turns our economic decisions over to sloth, greed, and envy, the ignorant passions of the people. But unlike in the market, sloth, greed and envy are not punished by government. Government failure is calcified and lives on for generations, with the solution always being more government.
But try advocating a policy of non-intervention. Unless you are an Emperor such as Kangxi (his non-interventionist policies led to an economic boom in China), the people will not settle for it. They haven't the patience. So they get the government and economy they deserve.